Why You Shouldn't Panic If Your Credit Score Drops


Credit scores matter — in a big way. Mortgage lenders rely on these numbers to determine who qualifies for home loans and at what interest rates. You'll struggle to qualify for the best credit cards if your score is too low. And getting an auto loan? A low score will leave you again with higher interest rates, if you can find financing at all.

So what if your credit score takes a fall? First, don't panic. Second, it's time to take the steps necessary to boost your score.

How Scores Work

Before panicking over a credit score drop, it's important to learn how scores work.

The most important credit score is your FICO credit score. Generally, lenders consider a FICO score of 740 or more to be in the top range. But if your score is under 640, you'll struggle to qualify for mortgage or auto loans. And when you do qualify, you'll pay high interest rates because lenders view you as a risky borrower.

Your credit score is a quick representation of how well you've handled your credit in the past. If you have a history of mailing in credit card payments late, your score will fall. If you've missed payments on your auto loan in the recent past, your score will, again, take a tumble. A large amount of credit card debt could hurt your score, too. (See also: The Most Important Ratio That Determines Your Credit Score)

If you instead have a history of paying your bills on time and have a manageable amount of credit card debt, you should have a solid FICO credit score.

Checking Your Score

You can order one free copy of each of your three credit reports — maintained by the national credit bureaus of TransUnion, Experian, and Equifax — each year from AnnualCreditReport.com. This report will list your credit card, auto, mortgage, and other open accounts. It will also list any of your missed or late payments from the last seven years.

This is important information to have: It can tell you quickly why your credit score might be lower than you thought. A single missed or late payment can drop your credit score by more than 100 points.

But a credit report doesn't list your credit score. To get your score, you'll usually have to pay. You can spend about $15 to order your FICO credit score from Experian, Equifax, or TransUnion. Each of the scores from these credit bureaus might be slightly different, but they should all be fairly similar.

Your credit card provider might provide your credit score with each bill it sends you, too. A growing number of card providers are doing this. Be careful, though: This score might not be your official FICO score, but instead an alternative score. These alternative scores do generally sync up with what your actual FICO score might be, but it's best to order your FICO score if you want to see the same credit score that mortgage and auto lenders will see.

If Your Score Has Dropped

What if your score has taken a fall since the last time you reviewed it? What if it's much lower than you expected?

Again, this is not the time to panic. It's the time to act.

First, try to determine why your score might have fallen. Some reasons are obvious: If you forgot to pay your auto loan earlier this year or if you sent in a credit card payment more than 30 days late, your score could dip by 100 points or more. But smaller dips — ranging from 10 to 60 points or so — can be the result of less obvious financial missteps.

Did you close a credit card lately? You might think that's a smart financial move. After all, once you've paid off a credit card account, you don't want to run up its balance again. By closing it, that can't happen.

But closing a credit card can ruin something called your credit utilization ratio. This ratio measures how much of your available credit you are using at any one time. Using too much of your available credit can cause your FICO score to fall. Closing an open credit card account can immediately weaken this ratio. (See also: 5 Times It's Okay to Close a Credit Card)

Here's an example: Say you have three credit cards all with an available credit limit of $3,000. This gives you a total available credit of $9,000. Say you also have $3,000 worth of credit card debt. You are now using 33% of your available credit.

If you close one of those cards, you'll immediately lower the amount of credit available to you by $3,000, from $9,000 to $6,000. If you have the same $3,000 of credit card debt, you are now using 50% of your available credit, for a significantly higher credit utilization ratio.

Another reason for a sudden fall in your FICO credit score: Have you been applying for several new credit cards? If you are, your score can fall. Every time you apply for a new form of credit, something called an inquiry is filed on your credit report. Each inquiry can cause your credit score to fall by a small amount, maybe one to five points. If you make several inquiries for new credit at the same time, this can cause a bigger drop to your score.

The good news is that inquiries don't always hurt your score by much. Say you are ready to apply for a mortgage loan and you are shopping around with different mortgage lenders. Each of these lenders will run a credit check on you. Each of the inquiries that these lenders make, though, will be counted as just one total inquiry. That's because you are applying for one mortgage loan, not several new credit cards.

Fixing a Drop

Once you determine why your credit score has fallen, it's time to fix the problem.

Realize, though, that if your score has fallen significantly from a missed or late payment, it will take time to recover. Pay your bills on time and cut back on your credit card debt. Do this for a long enough period of time — several months, maybe a year or longer — and your FICO credit score will steadily improve. (See also: How to Improve Your Credit Score Quickly)

If your score has fallen by a smaller amount, say 10 to 50 points, your recovery period will be shorter. Often, these drops will fix themselves. Pay down a good chunk of your credit card debt — without closing any credit card accounts — and your score should improve. Keep paying your bills on time every month, and, again, your score will rise.

There are no quick fixes for drops in your credit score. But there are also no scores that can't be rebuilt. All it requires is patience, a willingness to pay down large amounts of credit card debt and a vow to pay all of your bills on time every month.

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