Checking your credit score regularly is a good financial habit. That’s because it’ll allow you to monitor your credit history. While it’s perfectly normal to have your credit score change slightly month-over-month, if there’s a massive drop or things are trending downwards you’ll likely want to investigate. Here are some reasons why your credit score may have dropped.
You missed or made late payments
Your payment history is one of the major factors on credit reports that determine your credit score. Generally speaking, if you miss one payment in a 12-month period, your lender will be forgiving, and there will be no impact on your credit score. That’s because sometimes people make honest mistakes and forget to pay their bills. Many lenders will give you the benefit of doubt.
However, if you miss or make late payments twice in a row or more than once in a 12-month period, there’s a good chance your credit score will drop significantly and immediately. In the eyes of lenders, you’ve consistently been late with missed payments or not paying, so you’re no longer trustworthy when it comes to managing your credit.
Even if you’re struggling to pay your entire balance each month, try to make the minimum payment on time, By doing this, your account isn’t showing a late payment or non-payment.
You’ve increased your credit utilization ratio
How much credit you’re using relative to how much total credit you have access to is known as your credit utilization ratio. For example, if you have a total credit limit of $10,000, and you regularly charge $3,000 to your card, your credit utilization ratio is 30%.
The two credit bureaus in Canada: Equifax and TransUnion, typically want consumers to have a credit utilization ratio of below 35%. If you start carrying a higher credit utilization rate ratio, the credit bureaus will suspect that you’re having trouble managing your credit. This would negatively impact your credit score.
As odd as it sounds, asking for a higher credit limit would actually help you since you’d have access to more credit. If you’re spending the same amount, your utilization ratio would drop. The alternative would be to keep your spending down so the credit limits for you stay below the recommended 35%.
You’ve reduced your credit limit
Most people assume asking for a lower credit limit will help you since a lower limit means you can’t spend as much. However, as you’ve learned above, your credit utilization ratio can greatly affect your credit score, so a lower limit could hurt you.
Let’s use the same example from above. You have a credit utilization ratio of 30% since you normally charge $3,000 to your credit card, which has a total limit of $10,000. Since you’re concerned about your spending, you decide to call in and reduce your credit card balance limit to $5,000.
While this strategy will reduce the amount of available credit that you have access to, it would have increased your credit utilization ratio to 60%, which the credit bureaus may view as troublesome.
You applied for new credit
Whether it be a car loan or credit card, your credit score will drop a few points whenever you apply for new credit. A 10-point drop is not much in the grand scheme of things. However, if you’re new to credit scores, seeing that your credit scores drop, may throw you off.
There’s not much you can do about this dip in credit scores since a hard check on your credit history is performed whenever you apply for new credit. However, if you use your new credit responsibly, your credit score should increase after a few months.
You closed a credit card
Now that you know how credit utilization ratios work, you’ll naturally understand how closing a credit card can negatively impact your credit score. That said, which credit card you close may also lower your credit score. That’s because the length of your credit history is a factor in determining your credit score.
For example, let’s say you closed your oldest credit card that you’ve had for a decade. You’ve done this because the new credit card you applied for offers you better benefits. However, closing your older credit card would wipe out your history, so the credit bureaus would only have data on your more recent credit card.
As a general rule, you want to keep your oldest credit card active instead of cancelling it. If it has an annual fee, ask if you can switch to a no-fee credit card issuer instead to avoid any yearly fees.
You applied for a pre-approval mortgage
With the price of real estate being so high in Canada, many people seek to get pre-approved for a mortgage so they’ll know exactly what they can afford. What some people don’t realize is that during the pre-approval process, a hard credit check is performed, so your credit score will decrease.
If you prefer to avoid the credit hit, you could do a pre-qualification instead. That’s where you’d just run your numbers through an online calculator through your lender. That said, since pre-qualification is not a formal application, it’s just a number. A mortgage pre-approval is a bit more formal where the funds approved are like a promise. Mortgage pre-approvals typically last 90 to 120 days, so once you do it, you’re good for a few months.
You’ve applied for a new job
While employers don’t typically do a thorough credit check, there are some industries where a credit history and check may be required. For example, someone applying for a job in finance. The potential new employer may ask permission to run a credit check on you. They do this to ensure you’re not vulnerable to fraud. If you have a low credit score or have a bad history with credit, you might be tempted to steal from the company or accept bribes.
Admittedly, this may sound like a scene out of a movie, but potential employers need to be protective of their assets and take steps to avoid the mishandling of funds. Employers can’t perform a credit check without your permission. However, if you grant them the right to do so, your credit score will likely drop by a few points since a hard check is being performed against your credit profile.
You’ve signed a consumer proposal or declared bankruptcy
When your debt becomes unmanageable, a licensed insolvency trustee may recommend a consumer proposal or bankruptcy. With a consumer proposal, you’d try to negotiate a payment plan with your creditors. If accepted, you’d get to keep all your assets. However, if the debt is too much to handle, filing for bankruptcy might make more sense. With bankruptcy, you wouldn’t get to keep any assets except those exempt from the law. That said, you’d be getting a new start.
In both cases, you’re going to see a major decrease in your credit score. To make matters worse, a consumer proposal and bankruptcy stay on your credit report for quite a few years. Trying to get another loan during that time will be very difficult.
The information on your report is wrong
Occasionally, wrong information could end up on your credit report, which could reduce your credit score. For example, there might be someone with the same name or someone that lives at the same address as you. It’s possible for their information to get mixed up with yours. If this happens, and they have not maintained good credit stands, you could see your credit score drop.
Another example is when a former lender or service provider reports you for non-payment. This could happen when you’ve closed your account, but the service provider continues to charge you. Since you haven’t received any notifications, you have no idea about this outstanding balance until you check your credit report.
Resolving these issues can be complicated as you need to build evidence to support your claim. You would need to contact the service providers and the credit bureaus to get everything resolved. As you can imagine, this can take some time.
You’re a victim of identity fraud
If none of the above has happened to you that you’re aware of, then you may be a victim of identity fraud. That’s when someone poses as you and attempts to open multiple credit cards under your name. Since every application results in a hard check against your credit profile, you could see a huge drop in your credit score.
Identity fraud can happen to anyone at any time. The best thing you can do to protect yourself is to monitor your credit profile regularly or to set up alerts with Equifax and TransUnion if new credit applications appear on your credit history.
Why did my credit score drop for no reason?
It’s normal for your credit score to fluctuate a few points from time to time. However, it rarely drops by 10 points or more for no reason. If you notice a change and can’t explain it, you should check your credit report right away to see if you can figure out why the drop happened. It’s always best to be proactive as you could catch an error or fraud attempt before it gets out of control.
Barry Choi is an award-winning personal finance and travel expert. He regularly appears on various shows in Canada and the U.S., where he talks about all things money and travel. His website - Money We Have - attracts thousands of visitors daily, looking for the latest stories on travel and money.