By Adam Singer, helping consumers struggling with credit report errors to obtain corrections and compensation under the law. | Law Office of Adam G. Singer
Credit are a critical metric for assessing financial fitness. As your credit score goes up, interest rates on loans and lines of credit go down. The inverse is also true, and when your credit score drops suddenly, your financial well-being may be jeopardized just as quickly.
Credit score algorithms treat lower- and higher-risk consumers differently, even for the same negative credit event. In the case of a relatively late payment (a minor negative event), a high credit score suffers a more drastic drop than a low credit score. On the surface, this seems counterintuitive. The individual with the higher credit score presents the lower credit risk to lenders, so why does that healthy credit record suffer deeper repercussions? Score sensitivity is at play: A higher credit score is more sensitive to even small negative remarks, whereas lower scores will likely suffer less impact from those same remarks.
To those keeping a finger on the pulse of their credit score, a sizable, seemingly disproportionate hit from a creditor’s minor negative remark can be surprising and confusing. Other reasons for a downgraded score might be surprisingly surprising but perhaps not as nuanced. Below are five prevalent causes of sudden drops in credit scores—not an exhaustive list, but a springboard for understanding how certain activities can negatively affect your credit health.
Five Surprising Culprits Behind Dropping Credit Scores
1. Applying For Credit. Those with healthy credit have worked for it with a goal in sight—often, a home or vehicle purchase. However, with good credit comes unsolicited credit card and personal loan offers. It’s flattering when lenders court you and your responsible financial habits, extending you lines of credit paired with tempting offers. Don’t take the bait, especially if your existing mix of credit accounts is working for you.
Each application for new credit signals to credit reporting agencies (CRAs) that you’re experiencing enough financial stress to push you to open new lines of credit. This perception of need results in a decrease in your credit score. Remember, credit scoring algorithms consider the average account age—the longer the better. If you need more credit, increase a credit line on an existing card will often provide better credit score results (albeit with an initial short-term drop) than opening a new line of credit.
2. Sudden Increase In Credit Utilization. Credit can utilization account for one-third of an individual’s credit score. The percentage of your available credit matters significantly; Many consumers don’t realize that running up a $3,400 balance on a credit card with a $3,500 limit will reduce your credit score more drastically than accumulating a $5,000 balance on a credit card with a $20,000 credit limit. Maxing out a credit card signals a financial need that CRAs will flag as a sign of financial stress.
3. Paying Off Debt. Most are surprised to learn that a sudden drop in credit score can be attributed to healthy spending habits. While it’s true that high credit card utilization generally lowers credit scores, paying off that balance and then closing the credit card account will also hurt your credit score. A significant chunk of your credit score is determined by the age of your credit history; Closing the credit card account, even if it would lead to more responsible financial habits, zeroes out that history.
Similarly, paying off a loan could result in a credit score drop because an open account with a balance and timely payment history yields a more favorable credit score than no account at all.
4. Identity Theft. Identity theft covers a broad spectrum of illegal behaviors that can affect a victim’s credit score negatively. Through data breaches, criminals with access to account information can open and quickly max out new lines of credit. In “familiar fraud,” a victim’s family member or friend steals personal information for monetary gain, generally by opening accounts in the victim’s name. These forms of identity theft adversely affect two key creditworthiness factors discussed above (account longevity and degree of employment) because the consumer’s credit profile now shows new credit accounts that are soon maxed out. These compounding negative factors can cause a devastating drop in credit score.
5. Mixed Credit Files. CRAs are required by law to maintain accurate records, but oversights still happen. For instance, CRAs sometimes inadvertently commingle files belonging to individuals with very similar names or social security numbers.
Mixed credit files are problematic and often come to light after one person’s unhealthy financial behaviors are incorrectly attributed to another. Frequently, those whose files have been mixed don’t realize the confusion until their credit scores drop unexpectedly. CRAs should be held accountable in these circumstances.
Proactive Credit Score Monitoring
A sudden, unexpected drop in credit score can create alarm and frustration. Some of it can be avoided through conscientious management of your own credit activity, particularly regarding the first three culprits on our list. As for the final two, remaining proactive can help you thwart sudden credit score drops attributable to criminal misconduct or CRA oversight. You should thoroughly review your credit report from the three major CRAs (Transunion, Experian and Equifax) at least once per year. Currently, annualcreditreport.com allows consumers to check their credit reports weekly through April 2022 due to the economic disruptions wrought by Covid-19.
The information provided here is not legal, investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.