Your credit score carries a lot of weight in your ability to obtain credit, the amount of interest you pay to buy ordinary things, and it can even impact insurance prices and your ability to get jobs in specific sectors. It’s essential to know your credit score and understand how to safeguard it.
Many people are surprised to learn that even small actions cause ripple effects that can decrease your credit score. If you monitor your credit score routinely, you may find these changes perplexing. These are four reasons your credit score may have changed and why they affect your score in the first place.
1. You made a large purchase on your credit card.
Credit scores change all the time. Every financial action you make causes small adjustments to your score. If you recently made a large credit card purchase, it increases your Credit Utilization Ratio or CUR.
What is a credit utilization ratio? That is the amount of credit you have available compared to the amount of credit you’re using.
Here’s how it works. Assume you have a credit limit of $10,000 on your credit card. Then you went out and purchased $7,000 worth of furniture for a new home makeover. Now you are using 70 percent of the credit available on that card, which puts your credit utilization well above the coveted 30 percent line and causes a rather substantial dip in your credit score.
Ideally, you would be using 30 percent or less of your available credit. However, a large purchase can put you over the magic 30 percent mark, causing your credit score to go down. As you begin to pay down the debt, your credit score will improve.
2. You took out a loan.
Loans work a little differently than credit cards. Any new debt will cause your credit score to dip to some degree. The good news is that this dip in your credit score rebounds quickly once you begin repaying your debt by making timely payments.
Additionally, recent inquiries for loans or new credit cards will generate small dips in your credit score. These are usually temporary, and your score will recover.
3. You missed a payment.
This is a bigger deal, and something you should always seek to avoid with credit card and loan payments. Payment history plays a significant role in the credit scoring process.
If you fear you may miss a payment, always reach out to lenders BEFORE the payment is due to attempt to work out an arrangement. Seek a solution where your late payment will not be reported to the credit bureaus. Utilizing tools like autopay to pay at least minimum payments on credit cards each month can help you avoid accidentally missing payments.
4. You closed or paid off a credit card.
This is one that most consumers find shocking. Paying off debt is a good thing, isn’t it? While it is good to pay off the debt, closing the account reduces the amount of credit available to you, which in turn increases your credit utilization score.
Assume you have two credit cards, each with a $5,000 limit.
Balance Owed Credit Limit
CARD A $2,500 $5,000
CARD B $0 $5,000
Your total balance owed is $2,500, and your available credit limit is $10,000. This would make your CUR 25 percent. However, since CARD B has a zero balance, you decide to close the card. This will leave you with a $2,500 balance on a $5,000 credit limit, making your CUR 50 percent (well above the ideal 30 percent or lower range).
Keeping CARD B open and only using it occasionally for small purchases you can easily pay off each month is preferred for improving your credit score. However, if you find credit cards too tempting and have trouble managing debt, it will be in your best interest to close the card and work on paying down your existing balance.
We’re Here to Help!
As your credit union, we’re here to help you make the best financial decisions. If you have questions on how to improve your credit score or how a future action, such as taking out a loan, will impact your score, please give us a call at 202-479-2270 or email us at members@agfed.org.