Understanding Why Your Credit Scores Drop
Credit scores, those three digit numbers ranging from 300 to 850, are used by almost every lender in the United States to support their lending operations. The higher the score, the better the deals you’ll get on all forms of credit. And, if you’re accustomed to having really good credit scores then a sudden drop can be alarming, you should understand why your credit scores drop.
If you discover that all of a sudden you’ve got lower credit scores than you did previously, it’s generally a good idea to investigate the cause. The good news is there’s always, and I mean always, a plausible explanation as to why your credit scores dropped. The first step in your investigative work is to download copies of all three of your credit reports. Only then can you comb through them to identify the problem or problems. If your scores did take a nosedive it’s very likely because of one or more of these common reasons.
New Derogatory Information
Credit scoring models, such as those created by FICO and VantageScore, evaluate only the information on your credit reports. The scores they calculate are a direct reflection of your level of credit risk. As such, only information that is predictive of credit risk is considered.
Derogatory information is the most predictive information in this respect. It is a major red flag indicating that you might not be able to repay your debts as agreed. As such, when one or more of your creditors or debt collectors adds new derogatory information to your credit reports, it has the potential to make your score drop and drop big time. The drop can be especially pronounced if the new derogatory information is the only derogatory information on your credit reports.
Some examples of derogatory information that might cause score drops include:
· Late Payments
· Collection Accounts
· Charged-Off Accounts
· Foreclosures
· Repossessions
· Bankruptcies
· Accounts Settled for Less Than the Full Balance
An Increase in Revolving Utilization
Another common reason credit scores drop stems from an increase in revolving utilization ratios. Revolving utilization is a term that describes the relationship between your credit card limits and your credit card balances—as they appear on your credit report.
The utilization ratio is calculated by dividing your balances by your limits. For example, if you have a credit card on your credit report with a $1,000 limit and a $500 balance. The revolving utilization ratio on the account is 50%. The ratios are calculated on a card by card basis and also as an aggregate (all balances added together divided by all limits added together) metric. The higher the ratios, the fewer points you’re going to earn for those metrics.
The only way you’d have a significant upward spike in your utilization ratios would be if you took on an uncommonly large amount of credit card debt last month, if one or more of your card issuers closed your accounts, or if one or more of your credit cards has been removed from your credit reports. Anything that could lead to higher balances relative to your credit limits, as this appears on your credit reports, could cause the drop.
The Removal of Your Oldest Account
This reason normally gets overlooked, and it shouldn’t. It’s possible your score dropped because your credit report all of a sudden looks younger. There are credit report age metrics that are considered by scoring systems. The age of your credit history is worth 15% of your FICO score and is a significant factor in your VantageScore scores as well.
If this is what happened then the chronology of events likely looked something like this…
· One or more of your older accounts were removed (the reason is irrelevant) and one of those accounts may have been the oldest account on your reports
· Because of the removal of the oldest account your credit report’s “age” just became younger
· Because of the removal of old accounts, the average age of the accounts on your credit reports just became younger
This one can be hard to diagnose because it doesn’t involve adding anything new to your credit reports, including anything derogatory or a large amount of credit card debt. And, because you don’t check your credit reports often you may not notice that something has been removed.
In general, positive accounts that you actively use will remain on your credit reports indefinitely. The credit bureaus will purge most negative accounts from your credit reports after seven years as a matter of law. Closed, positive accounts are typically removed from your reports after 10 years, as a matter of choice. This is yet another reason why, in most cases, you don’t want to close unused credit cards. Once an account has been removed for one of these reasons it’s unlikely to ever appear again.
