Drops to your credit score can drastically affect your chances of being approved for a credit card, apartment rental or loan. If you have a low credit score, you may also end up paying higher interest rates on loans and credit cards than borrowers with high credit scores. This is because credit card companies and lenders want to ensure that they are lending money to people who have a history of repaying their debts and managing their finances well. If your score is on the low side, then lenders could compensate for that risk by charging higher interest rates.
Understanding what credit scores are made up of could help you manage your debt better and enjoy the greater financial benefits of having a good score.
What makes up my credit score?
Below is a breakdown of the six parts of your credit score, based on the VantageScore 3.0® model.
- Payment History (40%): You can establish a good payment history by making consistent, on-time payments and avoiding late payments.
- Credit History (21%): Someone with a longer credit history is seen as a lower risk borrower. It's beneficial to have a diversified history of different credit types, including student and auto loans, mortgages, and revolving credit card accounts.
- Credit Usage (20%): Credit bureaus use the ratio between the total balance you owe and your overall credit limit to see how much credit you're using. Keeping balances below 30% of your credit limit may help prevent drops to your score.
- Total Balances (11%): Paying your total balances (the lines of credit you currently have open) off regularly and reducing outstanding debt is usually in the best interest of your credit health.
- Recent Credit (5%): Your score typically drops every time you authorize a lender or business to make an official credit check, so it's important to apply for credit in moderation. If you're loan shopping, it's best to make all hard inquiries (also known as hard inquiry checks) within a 14-day window, as this is usually viewed by lenders as a single event.
- Available Credit (3%): the amount of unused credit that's currently available to you. It's the difference between your credit limit and balances across all your accounts. Adding more open lines of credit could improve your score in the long run.
Why did my credit score drop?
Your credit score may have dropped because:
- You missed a payment: A single missed payment on your credit card can cause your credit score to drop.
- You have too many hard inquiries or credit checks: Regularly applying for new credit cards (and being rejected) tells lenders that you may be looking to add on more to your existing debt before paying off what you currently owe.
- You maxed out your card: Your credit utilization ratio (how big your credit card balances are versus your total credit limits) will take a hit in a negative way if you have reached your credit limit for one or more cards or even if you are close to reaching the max.
- Debt was sent to collections: Missed payments reported to collections by your utility company or landlord will reflect negatively on your credit score.
- You co-signed a credit card user: If you were a co-signer for a loan, your credit score could decrease if the consignee misses a payment or makes late payments to the account you are tied to.
- You closed one of your oldest credit card accounts: If you closed your oldest credit card account, your length of credit history may be shortened and your available credit could also be lowered. These can have a negative impact on your credit health.
- Your credit utilization ratio may have increased. The first line of credit you opened (which is likely to also be your oldest account) remains on your report and will show lenders how committed and consistent you are with long-term payments.
- Mistakes on your credit report: Errors on your credit report can hurt your credit score. By monitoring your credit report, you can confirm that your personal details are correct and that you recognize all the lines of credit tied to your name. If you spot any errors, contact the credit monitoring company you currently use for more information on how to report fraud, errors and more.
How can I raise my credit score?
You can improve your credit score by making consistent on-time payments, avoiding late or miss payments and avoiding new credit inquiries (also known as hard credit checks) if your credit score is on the low-end. You are likely to see positive changes to your credit score over a period of time. Your credit score is a big deciding factor in being approved or denied for student loans, home rentals, credit cards, and mortgages, so it's important to monitor it carefully for any activity that you could improve on. By improving or maintaining a good credit score, you could increase your chances of being approved for more lines of credits you may need in the future and possibly pay lower interest rates.