By Sean Cooper
Did you notice a drop the last time you checked your credit score?
There are many things that can lower your credit score. Some things, like missing a payment, shouldn’t come as a shock, but others, like closing an account, may come as a surprise.
Here are some common reasons that your credit score may drop and the credit factors that contribute to them.
1. You’ve missed or made a late payment
Your payment history is typically the most important credit factor used to calculate your credit score. It tells lenders how likely you are to repay debts in the future.
If you’ve missed payments or made late ones, lenders may be hesitant to extend credit to you -- or may offer you credit, but at a higher interest rate. The longer you make your payment after your due date, the more it could affect your credit score.
And if your payment is past due and sent to a collection agency or you declare bankruptcy, it can also adversely affect your credit score and stay on your credit report for six or seven years.
2. Your credit utilization is too high
Your credit utilization is typically the second most important credit factor when it comes to how it affects your score. It may also be called “use of available credit.”
To determine your credit utilization, add up the balances on your various credit products, such as credit cards, lines of credit and car loans, and divide the total by your total credit limits.
Lenders are most concerned about how much credit at your disposal you’re actually using, not your credit limits on their own. Even if you keep making payments on time, you’re seen by lenders as a higher risk of default if your credit utilization is high.
3. You recently closed (or opened) an account
If you’ve recently opened or closed a credit account, this can negatively impact your credit score. Generally speaking, the longer your credit account is open and in good standing, the more it may help to improve your credit health.
This means that if you close an old credit account, such as the first credit card you signed up for in university, and your other credit accounts are relatively new, your score could drop.
For example, if you’re doing a balance transfer from an old credit card to a new credit card to take advantage of a low introductory interest rate and you close your old account, that may cause your credit score to drop.
3 tips for improving your credit health
If your credit score isn’t as high as you’d like it to be, there may be things you can do to help improve your credit health.
Tip #1: Don’t make late payments.
If possible, aim to always make your credit payments in full by the due date.
If your cash flow is tight, try to at least pay the minimum payment (you can find this on the statement from your lender) to keep your credit account in good standing.
If you’re unable to make the minimum payment, let your lender know immediately to see if a special arrangement can be made, such as spreading your payment over a longer period of time or negotiating a lower interest rate.
“To make sure you never miss a payment, I recommend setting calendar reminders to log in and make payments to your credit accounts twice per month. This could help ensure that you’ll never be late for a payment and give you ample opportunity to review your statements and recent transactions for inaccuracies and fraudulent charges,” says Stephen Weyman, personal finance blogger at HowToSaveMoney.ca.
Tip #2: Keep your credit utilization below 35 percent.
The Financial Consumer Agency of Canada recommends keeping your credit utilization at less than 35 percent of your total available credit. Generally, having high credit utilization may hurt your score as your lender may view you as more likely to default.
For example, if you have two credit cards with a $6,000 total limit, try to keep your combined balances below $2,100 (35 percent of your $6,000 total available limit).
Tip #3: Keep your older credit accounts open.
While it may be tempting to close older credit accounts that you no longer use, consider keeping them open. For example, it might be worth keeping your first credit card, even if you seldom use it, provided there’s no annual fee.
If your credit card has an annual fee and you’re not using it, consider closing or downgrading it to a non-annual fee version (if available as an option).
Be sure to use your credit card every so often to avoid an inactive fee – or your issuer closing your account. An inactive fee is a fee charged by credit card providers if you don’t use your credit card for a time period (typically at least a year).
Should you always be concerned about a drop in your credit score?
A drop in your credit score may be a concern, but it can depend on the reason for the drop, or your particular credit standing at the time of the drop.
For example, your score may drop slightly if you apply for a new line of credit because a lender has made a hard inquiry into your report. If you have excellent credit, the effect of a hard inquiry may be less than if you have good or fair credit.
On the other hand, paying your credit card late could cause a much bigger drop in your score. Likewise, you don’t want too many hard credit inquiries (credit inquiries that are included on your credit report and may impact your credit score).
For instance, applying for five credit cards in a month may adversely impact your credit score. But generally, you don’t need to fear shopping around for auto loans or mortgages – multiple inquiries within a short period of time could count as only one inquiry from a scoring perspective.
Also, many landlords and some employers perform credit checks. Again, these may cause your credit score to temporarily fall.
Bottom line
There are several reasons why your credit score may fall. Figure out why your credit score is lower and take the necessary steps to correct the behaviour that triggered it.