Having your credit score fall unexpectedly can be as bad as losing a significant amount of money. With a lower score, your opportunities for low-interest loans, lower insurance premiums, and more affordable mortgages may be out of your reach.

What’s worse is that these fluctuations may come from out of nowhere and may confuse you on where to begin. Just how did this happen?

In this article, we’ll take a look at a number of different factors that can affect your credit score so you can find proactive solutions and stop your credit from taking a nosedive.

Investigate Your Credit Report

Depending on how you found out about your credit score dropping, you’ll have to do some detective work.

Your first step is to get a copy of your credit report, which is free once a year from the three major credit bureaus (Experian, TransUnion, and Equifax). Look for any errors or unexpected “potentially negative items” that you may have thought were resolved or in good standing. If you’ve found a discrepancy, contact the institution (or collection agency) to determine what proof/documentation you need to file a dispute.

If you haven’t found any errors on your credit report, then it’s time to turn your attention to your recent credit-related behavior (see Possible Reasons for a Sudden Credit Score Drop below)

Filing a Dispute

If you haven’t had a chance to review credit reports from each of the three bureaus, do so—other errors may be present, which may alert you to potential identity theft or fraud.

Once you’ve determined that damage to your recent credit score is in error, you should determine whether the error is easy to resolve. Sometimes it may just take contacting your creditor directly to overturn the mistake. If it seems like more involved error, contact the three major credit bureaus directly file a dispute.

Technically, you have two options when filing a dispute: you can contact either the credit bureau, or you can contact the data furnisher (the company that provides information to each bureau). For a quicker response, the data furnisher may be your best option, but they aren’t legally obligated to pursue every type of dispute and most only accept disputes through the mail.

Contacting the credit bureaus directly allows you have the convenience of applying online, it adds a legally-binding statement to help clear your name to your creditors, and they’re legally obligated to contact the institutions (including the data furnishers) that are affected by the error. The catch is that the dispute may take 30 – 45 days, though many are resolved within two weeks.

Once you’ve heard back regarding your dispute, be sure to check your credit reports again as a follow-up. Most of the time, the error may be resolved, but it helps to double-check.

Possible Reasons for a Sudden Credit Score Drop

Short of filing a dispute, if you cannot find what has caused your credit score to drop on your credit report, it may be time to dig deeper into your recent activity. Consider each of the following topics and determine if they’re at-fault for your current credit score.

Credit Utilization Rates

If you have a significant amount of debt on your credit cards (even if you’re making regular payments on the interest), you may have your credit score drop despite your best intentions. The reason is that credit issuers view your “credit card utilization rate” as insight into how much credit you’re relying on. Lenders frown upon this behavior, as they wish to receive the interest payments and the principal instead of “robbing Peter to pay Paul” as a financial strategy.

The formula for calculating your credit utilization is by dividing your total credit card balance by your total credit limit. As an example, if you have one credit card with a $1,000 balance and a $3,000 credit limit. $1,000/$3,000 = .33, meaning you would have a credit utilization rate of 33%.

As you can guess, this percentage is subject to change from month-to-month as you use your available credit and/or pay off your balance. This can make your score fluctuate, even if you haven’t missed a payment.

Credit utilization is directly related to your FICO score on both an account-by-account basis and on an overall basis. According to Tom Quinn, the Vice President of Scores at FICO, it’s best to aim for a credit utilization rate of 1% – 20%. Essentially, the lower the utilization percentage, the better.

Solution: The best way to increase your credit score is to pay down your existing debt. Another strategy is to increase the amount of available credit by requesting a credit limit increase from your credit card issuer, or by opening a new credit card entirely

Payment History

If there’s one piece of advice creditors can give their clients, it is to never miss a payment. One 30-day late payment can drop your credit score significantly. The reason for this is because creditors are trying to judge your ability (and likelihood) of paying back your debt, which is critical to their business model.

Bear in mind that a late payment also mars your credit history, staying on your file for up to 7 years.

Solution: Obviously, paying on time is critical, but a missed payment may be an indicator of not automating your finances. Linking your checking accounts to your credit card for automatic transactions can help those who are too busy or forgetful.

In addition, if your credit card issuer has bill reminders, be sure to turn them on. And, as always, make sure to monitor your credit report to ensure that your payments are being reported accurately.

Derogatory Marks on Credit History

One cause for a major drop in your credit score can be a derogatory mark on your credit report. These derogatory marks can include:

• tax liens from the IRS
• bankruptcy
• accounts in collection
• foreclosure
• civil judgments

While these marks may expire after seven years, you can take action and file a dispute as indicated before if there are inaccuracies within your report. In addition, the IRS offers the “Fresh Start Program,” which allows you to have paid tax liens removed from your credit history after filling out IRS Form 12277. For more information on this program, visit the IRS page here. 

FICO Changes

While it’s not entirely within your control, FICO makes changes to the formulas they use to calculate your credit score to more accurately indicate risk to creditors. These formula changes also include non-FICO related credit scoring formulas, too, so you may find your score dropping without warning.

There’s also another similar explanation that goes on behind the scenes of FICO. You may have been placed into what is referred as a new “scorecard.” Scorecards are a way for FICO to differentiate between consumers who have similar financial histories and are graded accordingly. When FICO changes your scorecard—thus affecting your credit score criteria—it is called “scorecard hopping” to credit professionals.

To protect creditors from those that wish to manipulate their FICO score, FICO provides little information about how each consumer is ranked within their scorecard process. However, most creditors agree with the inference that those with bankruptcy on their credit history are evaluated similarly. Similarly, when bankruptcy is removed from your credit history, your credit score will be judged on a new scorecard that features its own criteria.

The catch is that hopping to a new scorecard can actually lower your score (despite your improvements), as you’re now subject to a new set of credit score rules. The reason for this is that you’re being evaluated against a new set of consumers, who’ve had a longer period within that scorecard bracket. This could result in a credit score drop in the short term until your credit improves within that new scorecard’s criteria.

New Credit Card Applications

Did you know that applying for new credit cards can lower your credit score? Looking for a multiple new credit cards within a short amount of time equates with risk for credit issuers, so be aware that you may be making a trade-off for seeking credit at the expense of a reduced score.

Note that credit inquiries from auto, mortgage, or student loan lenders don’t have as great of an impact on your score.

Open Credit Lines

The longer you’ve had lines of credit open, the more creditworthy you appear to lenders. However, if you’ve closed a credit account recently, your credit history may appear to be shortened, which may result in a drop for your credit score. On the other hand, opening up a new account may drop your score, as this creates a new line of credit without having an established history of on-time payments. Also, it should be noted your credit score may drop when you’ve finished paying off of a loan.

Solution: Before closing any credit-related account, consider how it may ultimately affect your overall credit score. Be sure to look at your credit report and compare the amount of closed accounts to the currently open ones. Having a disproportionate number may indicate to creditors that your finances may be in peril—either you’re financially-strapped and need more credit or your existing credit accounts are suffocating your finances.

Hard Credit Inquiries

Generally speaking, when you’ve applied for a new form of credit (ie. credit card, auto loan or mortgage, etc.), something called a “hard inquiry” is placed on your credit report. Single inquiries may drop your score by a few points; if you’ve applied for several accounts in a short period of time, you could appear desperate for credit, and the damage from those hard inquiries might add up.

Solution: If you plan to avoid having your score drop at all, follow a few smart practices:

• apply for credit only when you need (and can afford) it
• focus on credit cards that you believe you’ll have a good chance of getting approved for
• consider getting pre-qualified or pre-approved for credit, so you have a better sense of what you’ll be approved for before you apply without affecting your score

By doing research beforehand, you may be able to avoid unnecessary hard inquiries.

To a normal consumer, a credit score may seem like mysterious bit of financial hocus-pocus. But, as you can see, with a little education, you can pinpoint and control just how your credit score behaves, avoiding all of the common mistakes and hidden pitfalls of keeping your credit score high and healthy.