A decline in your credit score can be disheartening, especially since a great credit score often takes years to build. Understanding why your credit score may have dropped can help you make changes to boost your credit score going forward.
Let’s go over what your credit score is, how it’s calculated, and what you can do to improve it.
What is a credit score?
Your credit score is a number between 300 and 850 intended to represent your creditworthiness. A high credit score indicates you’re more likely to repay a loan that’s made to you. A lower credit score indicates that you may be less likely to make on-time payments on any debt.
The lower a person’s credit score, the more perceived risk for a lender. If your credit score is too low, you may have a hard time finding a loan. Alternatively, lenders might charge you a higher rate of interest.
How are credit scores calculated?
Credit scores are based on five factors:
- Whether you pay on time. The biggest and most important component of your credit score relates to whether you pay your bills on time. Keep in mind: Not every missed payment gets reported to the credit bureaus. However, paying off any overdue balances can help you improve your score.
- How much money you owe. This calculation looks at the credit available to you and how much of it you’re using. If you have a $40,000 credit card limit and you owe $38,000 on the card, you’re considered riskier than having a $40,000 credit card limit with a $4,000 balance. Of course, your credit score factors in all of the credit available to you, not just a single card.
- The type of debt you have. Secured debt, such as a mortgage or auto loan, is rated differently than unsecured debt, like a credit card balance.
- Whether you’ve applied for credit recently. An individual who’s recently opened a number of new credit accounts may be seen as riskier than someone who hasn’t applied for credit recently.
- The amount of time you’ve been borrowing. In general, the longer your credit history, the more reliable you appear.
While there are three main credit bureaus that keep a record of your credit history—Experian, TransUnion, and Equifax—all three use your FICO score as their base.
Many financial institutions, including credit card issuers and banks, will share your current credit score with you. Some may even flag any recent increases or decreases, as well as what caused them.
The biggest reason for a major drop in credit score tends to be missed payments. You may also notice smaller drops if you’ve recently applied for a loan or credit card.
If you notice a change in your credit score that doesn’t make sense to you, check your credit report.
Check your credit report
Your credit report is different from your credit score. These reports, provided by the three credit bureaus, document your credit history. You’re entitled to a free credit report from each agency every year.
Access those reports via https://www.annualcreditreport.com. This is the only legally authorized source; be sure to check the URL and watch for scams.
Reviewing your credit report can help you understand what goes into your FICO score. It can also help you spot problems.
For instance, if your credit report includes a loan that you didn’t apply for, you can flag that to the credit agency and ask them to correct the error. Mistakes can happen, but errors on a credit report can also indicate identity theft or fraud.
Should you worry about your credit score?
Your credit score is important, but it’s just one factor of your overall financial health. It matters more if you are planning for a large purchase or if you’re hoping to refinance to a lower interest rate on an outstanding loan.
A comprehensive financial plan can help you stay on top of your credit score. It’s important to remember that debt isn’t necessarily negative. Leverage and credit can sometimes be used strategically to improve your finances. A financial advisor can help you ensure you’re taking on a safe amount of debt and managing it strategically so as not to derail your finances overall.
If you have questions about managing debt or how debt might impact your ability to reach your financial goals, contact a Bogart Wealth Advisor.
