all about How To : 5 Lesser-Known Reasons Why Your Credit Score Drops

Credit Score Dropped? 5 Lesser-Known Reasons Why Lauren H. says “I subscribed to your podcast after a friend recommended it a few months ago and have really enjoyed it. I find myself more frequently discussing money issues with my friends and these honest conversations really help all of us to get a better handle on our finances.

Here’s my question: Each month I receive my FICO credit score on one of my credit card statements and last month my credit score dropped 16 points. I checked my Experian credit report and didn’t find anything wrong. I don’t have any late payments, closed cards, or new accounts. What might be the reason for this drop?”

Lauren, thanks for your question and being a new show listener. I know how frustrating and shocking it can be when your credit score drops suddenly for no obvious reason.

In this post we’ll cover 5 lesser-known reasons why credit scores can drop unexpectedly. I’ll give tips to raise your credit score as quickly as possible so the drop doesn't hurt your finances.

See also: The Credit Score Survival Kit (a free video tutorial to build credit fast!)

How Credit Scores Work

Credit scores can seem mysterious because they’re created using many factors in your credit report. There are hundreds of different credit scoring models used by companies such as mortgage lenders, vehicle lenders, insurers, and merchants.

Each scoring model uses a complicated algorithm to evaluate your credit history. They all use slightly different factors and scoring ranges--some even use letters instead of numbers.

Additionally, there are 3 nationwide credit bureaus (Experian, Equifax, and TransUnion) that may not have the same information about you since creditors may only report data to one or two of them. So your credit score depends on which credit report is used in conjunction with which scoring model.

FICO is one of the most popular scoring model and uses a score range from 300 to 850. The higher your number the less risky you appear to potential lenders and merchants.

FICO is very transparent about the factors and weights they use to calculate your credit score: Credit Score Factors

Payment history: 35%
Amounts owed: 30%
Age or length of credit history: 15%
New credit inquiries: 10%
Mix of credit types: 10%

Since Lauren doesn’t have any late payments or changes with her accounts and still had a 16-point credit score drop, what gives? Well, some changes to your scores may not be easy to spot because they’re happening behind the scenes due to not-so-obvious reasons.

Related: 5 FAQs About Your Credit Score

5 Lesser-Known Reasons Why Your Credit Score Dropped

Here are reasons why your FICO or another brand of credit score could drop, making you appear riskier to potential lenders and merchants.

Reason #1: You made an expensive credit card purchase

Lauren didn’t mention her recent spending patterns, but making a larger than normal credit card charge is one of the most common reasons for an unexpected credit score drop.

As I mentioned, the amount you owe makes up about one-third of your score. And the driving force behind it is something called credit utilization. Your credit utilization ratio is a simple formula compares the amount you owe to your available credit limit on revolving accounts, such as a credit card or a line of credit.

For example, if you have a credit card with a $1,000 credit limit and just bought a TV that brings your total balance up to $900, you have a 90% credit utilization ratio. In general, the lower your ratio, the better for your credit scores. Maintaining a utilization below 20% will give you the biggest benefits for your credit.

But wait a minute. What if you pay off that $900 balance by your credit card’s statement due date? Many people mistakenly believe that they can max out a credit card as long as they pay it off on time.

Here’s why that doesn’t work. Your credit card company could report your balance to the credit bureaus before your payment was received. In other words, paying off your entire credit card balance every month generally does not improve your utilization ratio.

The bottom line is that if you’ve been using more of your available credit lately, it’s a mathematical signal that you might be in financial trouble and could make late payments in the future.

In order to reduce your utilization ratio and boost your score you have the following options:

Charge less each month
Ask for a credit card credit limit increase
Open an additional card and spread out charges on multiple cards
Make multiple payments during the month so a lower balance gets reported to the credit bureaus

The bottom line is that if you’ve been using more of your available credit lately, it’s a mathematical signal that you might be in financial trouble and could make late payments in the future.

To raise your FICO or other credit scores never charge more than 20% of your available credit on any one card or on a total of all your cards.

Reason #2: One of your credit limits was reduced

I mentioned that getting a credit limit increase on a credit card is one way to reduce your utilization ratio and increase your credit scores. Likewise, your credit can take a hit if your available limits are cut.

Card issuers set your spending limit when you first open an account, but they can increase or decrease it according to the terms of your agreement. If the issuer sees signs of risk, such as you taking large cash advances on your card or exceeding your credit limit, they can take action to protect themselves by reducing your credit limit.

Having less available credit affects your utilization in a way similar to charging more. Your utilization ratio goes up and your credit score will quickly go down.

For example, if you have a card with a $1,000 credit limit and an outstanding balance of $200, you have a 20% credit utilization ratio, which is an acceptable amount.

But let’s say your credit limit on the card is cut to $600 and you still owe $200. Now your utilization just shot up to 33% ($200 / $600 = 0.33 = 33%) and your credit score will drop.

If this happens be sure to review your credit report for any inaccurate information that might be the reason why the card issuer cut your limit. Then contact the company to get any mistakes cleared up and discuss raising your credit limit.

Reason #3: You have zero credit utilization

While having low credit utilization on revolving accounts is one of the best ways to improve your credit scores, don’t go overboard by going down to zero utilization.

For instance, if you pay off your card and don’t make additional charges, some credit scoring models ding you. It’s better to have credit accounts and to use them responsibly than to let them become inactive.

In other words, showing some amount of activity, such as making small charges and paying them off in full each month is a smart credit strategy.

Reason#4: Your average age of credit accounts changed

The age of your credit accounts tells a story about how experienced you are handling credit. That’s why credit scoring models evaluate the average age of your accounts. It's typically figured as the total months that all of your accounts have been open, divided by the number of accounts you have.

Having a long credit history helps lenders know if you’re likely to be financially responsible in the future and are a good credit risk. So, the longer you’ve had credit accounts open in your name, the better.

Once a credit account is closed or paid off, your average age of accounts begins to decrease. If you choose to close a really old account, the cancellation has a more negative affect on your credit scores than if you closed a younger one. Also, when you open a new account, you immediately reduce the average age of your accounts, which may cause a sudden credit score drop.

To make sure your average age of credit accounts will grow over time, only open new accounts when it’s absolutely necessary. And make sure to keep your oldest accounts open and active.

Many people want to close a credit card immediately after paying it off because they think that’s better for their credit. If you can’t use a card responsibly, then you should close it.

But another option that’s better for your credit is to pay off the card, but leave the account open. That allows you to leverage its positive payment history, longevity, and available credit limit to raise your credit scores.

Reason #5: Your credit mix has changed

While it’s not the most important factor in how your FICO or other credit scores are calculated, having a mix of different types of accounts helps increase your credit scores.

For instance, having revolving accounts, such as a credit card or line of credit, in addition to installment accounts, such as a car loan or mortgage, shows lenders that you can handle different types of credit responsibly.

So, if you just paid off the only installment loan you have, your credit mix looks less diverse to lenders and there’s not much you can do about that. Unless you need to finance a purchase, like a home or car, I don’t recommend taking a loan just for the sake of boosting your credit.

If you maintain good habits, like paying credit cards and utility bills on time, and maintaining low utilization rates, your credit scores will naturally go up over time.

As is often the case, you’ll get the best scores by using credit — as long as you use it wisely.

A final tip is to check your credit report using a free site like Credit Karma to make sure there are no errors dragging down your credit scores. Inaccurate information could be a sign that a lender reported bad data to your file or that you've become the victim of identity theft. Dispute any inaccurate information with the credit bureau right away so it won't hurt your finances.

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all about How To

Rabu, 28 September 2016

5 Lesser-Known Reasons Why Your Credit Score Drops