It’s hard to make any kind of financial decision these days without considering how it might impact your credit score. And it's no wonder! Your credit score could make the difference between getting that rental apartment you've been eyeing (or not) or even qualifying for a great cell phone plan or insurance rate. The truth is many important financial transactions rely on your credit score. That's why it's important to know if your credit score has dropped and what might have caused it.
It’s always a good idea to track your credit score. Not only can significant changes in your credit score help you identify potential cases of identity theft and fraud, but they can also help you address any discrepancies in your credit report and take the necessary steps to correct actions that might be causing your credit score to drop. For this reason, many Canadians have started tracking their credit score regularly and checking with both Equifax and TransUnion to get updates when it does change.
Have you ever wondered, “Why is my credit score dropping?” or “How can I improve my credit score?” Let’s go through what a credit score is and how you can take control of it!
What Is a Credit Score?
Before jumping into what to do when your score drops, it’s important to understand a few things about how credit scores work. Your credit score is a three-digit number ranging between 300 and 900, and it's based on information contained in your credit report. Canada has two credit reporting agencies (also known as credit bureaus): Equifax and TransUnion. Each credit bureau maintains their own credit reports and credit scores, but they shouldn't vary too much.
Your credit report is essentially a record of your past financial behaviours and actions when it comes to credit, including credit cards, loans, and bill payments. Lenders look at your credit score to determine and predict your ability to repay financial obligations as agreed to, such as loans and credit.
In general, a credit score above 660 is considered good, a score above 725 is considered very good, and anything above 760 is considered excellent. However, if your credit score is below 660, you may find it more difficult to obtain credit and/or qualify for good loan rates.
How Are Credit Scores Calculated? 5 Factors Credit Bureaus Look At
It’s also really important (especially if you’re trying to raise your credit score) to understand how your credit score is calculated. That way, should you want to address any drops in your credit score, you can identify the key issues impacting your credit score the most and work to resolve them.
There are five main factors credit bureaus consider when determining your credit score. They are (in order of importance):
1. Your Payment History
This is, by far, the most important component of your credit score. Whether or not you’ve paid previous creditors, and paid them on time, is the biggest indicator to other lenders whether you’re going to pay them back or not. Your credit report will also indicate whether the payments you made were late, by how much, and whether that’s a regular occurrence for you or not.
Your payment history isn't just related to your credit card payments. It also includes any other credit items you might have, such as loans (car/student/personal), as well as any other debts you have where you make regular, ongoing payments.
2. How Much You Owe to Your Creditors
When deciding whether or not to lend you money or provide you with additional credit, creditors want to know how much you already owe other creditors. This information helps them determine if you can handle any additional debt.
For example, if your existing credit cards and/or lines of credit are close to being maxed out, creditors may interpret this as high risk, as you're already carrying quite a bit of unpaid debt. When creditors see that you have already used up a good portion of your existing credit, it's an indication that it could impact your ability to repay them if they were to extend to you additional credit.
3. The Length of Your Credit History
The longer you have a history of credit and repayments, the better your credit score will be. Why? Because over time you’ve demonstrated your willingness and ability to repay your debts as agreed.
While it's not the biggest factor, it's still quite important. In fact, having no credit history lowers your score as creditors don’t know your “track record” nor do they know how you’d handle any financial difficulties that may arise.
4. Your Applications for Credit/Loans
If you’re regularly applying for new credit cards or loans, it may suggest to creditors that you're struggling financially and are in need of money. In turn, that can make you appear as a high-risk borrower. For that reason, frequent applications for new credit can drop your credit score.
Each time you apply for new credit, creditors may check your credit report, which is considered a hard inquiry – and hard inquiries can lower your credit score. Your credit score also factors in the number of credit accounts you’ve recently opened. When these two factors are paired, they can indicate to creditors that you're having difficulty keeping up with payments.
Simply put, don't apply for too much credit in a short amount of time!
5. Types of Credit Used
Because different types of credit/loans have different types of repayment options and terms, they can reveal different information about your ability to repay your debts. That's why creditors typically like to see different types of credit on your credit report.
For example, two common types of credit are revolving or recurring credit (e.g., credit cards, home equity lines of credit or HELOCs) and installment loans (i.e., student loans, auto loans).
Revolving credit allows you to borrow money up to a certain limit, then you make regular monthly payments to pay it off. Your monthly payment amount can change month-to-month based on how much you've borrowed.
Whereas installment loans mean you've borrowed a specific amount of money and you make the same monthly payment over a fixed period of time.
It’s worth noting that every lender can interpret the information on credit reports differently. So, they may have different risk tolerances and thresholds for their own lending decisions.
What Causes a Credit Score to Drop?
The factors listed above are usually related to a drop in your credit score. For example, if you have late payments, applied for multiple lines of credit/loans in a relatively short amount of time, and/or have increased your overall debt load, you may find that your credit score has taken a hit, and as a result, you have a low credit score.
If you've recently noticed a drop in your credit score, it may be due to one (or more) of the following reasons:
A Payment Was Late or Is Missing.
Payment history on all types of debts has a huge impact on your credit score (it makes up 35% of your score!). The later the payment is, the greater impact it will have on your credit score. If you're 30 days late or more, your credit card company or lender is likely to report the problem to Equifax and/or TransUnion, which can automatically lower your credit score. After 60 to 90 days, the negative impact on your credit score increases.
Even making the minimum required payment on time can prevent this problem. If you're not always on the ball when it comes to making your payments on time, consider setting up auto-payments for your credit card bills, even if it's just $20. That way, you won't get docked for unnecessarily late payments.
You Made a Large Purchase with Credit.
The ratio of your total debt compared to how much available credit you have is an important part of your credit score. The more available credit you use, the lower your credit score typically is. Whether you decide to use a significant portion of your credit to pay for a home reno or purchase a number of big-ticket items (e.g. appliances, television, laptop, cell phone, etc.), a credit score drop is likely to follow if you don't pay off the balance in full.
Your Credit Limit Decreased.
Having your credit limit decreased by a creditor can impact your credit score because it affects your credit utilization ratio (the amount of credit you have available versus how much you've used). A creditor may decide to decrease your credit limit due to repayment issues or changes in income, but it might just be because the credit card or line of credit is underutilized.
Your Account Was Sent to Collections.
If you're simply unable to pay an outstanding balance on an account and the company decides to send your information to a collection agency, the credit reporting agencies will consider you a greater borrowing risk, which will then lower your credit score. If a creditor sends your account to collections, it can take six years for this information to be removed from your credit report.
You Applied for Additional Credit and Lenders Checked Your Credit Report.
It might seem unfair, but your credit score will take a hit if you've applied for new credit and a bank or lender checks your credit report to assess the risk you pose as a borrower. As previously mentioned, when a lender looks at your credit report because you've applied for new credit, this is considered a hard inquiry – which can lower your credit score.
But not all inquiries will hurt your credit score — it all depends on the type of inquiries they are! For example, if you check your own credit report or credit history, this is considered a soft inquiry, and soft inquiries have absolutely no impact on your credit score.
Hard inquiries can stay on your credit report for up to three years, but they only account for about 10 percent of your overall credit score.
You're a Victim of Fraud.
One of the most important reasons to check your credit report is to make sure you're not a victim of fraud. Inaccurate information on your credit report or fraud will impact your credit score, so checking your credit report and credit score is a financial security measure everyone should take and part of your overall financial health.
Mistakes happen and sometimes information gets incorrectly reported to credit bureaus regarding missed payments. But a bigger risk is identity theft where individuals will use your information to apply for credit.
Simply put, your good credit score is an attractive target for thieves. If a hacker steals your personal information, they can open new credit accounts or apply for new loans, while not making any payments towards them, leading to multiple delinquent debts for you. The result? A poor credit score and credit rating.
Your Credit Card Was Closed.
Much like having a credit limit decrease, closing a credit card can have a similar impact because both of these changes impact your credit utilization ratio.
For example, if you just have one credit card that has a $2,000 limit and you owe $600 on it, your credit utilization ratio is 30 percent (which is considered good). But if the creditor drops your credit limit down to $1,000, your credit utilization goes up to 60 percent, which makes you a greater risk as a borrower.
Similarly, if you have a credit limit of $2,000 between two credit cards ($1,000 each), and you owe $600 on just one of those cards, your credit utilization ratio is still 30 percent. But if you then choose to close the card that has a zero balance because you don't use it, now all of a sudden your credit utilization jumps up to 60 percent, which can drop your credit score.
The longevity of accounts shows lenders that you're a trustworthy borrower. By closing an account, you lower your overall credit availability, which in turn impacts your credit score.
You Filed for Bankruptcy.
As you can imagine, a major financial event, like bankruptcy, can have a significant impact on your credit score. That's why bankruptcy is seen as an absolute last resort and should only be considered by borrowers who have no means for paying the debts they owe.
Many people are surprised by just how much their credit score is affected when they successfully file for bankruptcy. Bankruptcies in Canada can stay on your credit report for up to six to seven years, depending on the credit reporting agency. And if you file for bankruptcy a second time, it can stay on your credit report for up to fourteen years.
Learning how to avoid bankruptcy is important for anyone who is struggling to keep up with their financial obligations and monthly debt payments.
How to Raise Your Credit Score If It Drops
Rebuilding your credit and increasing your credit score is a priority, especially if your future goals include a major purchase, like a home or a car, renting a new apartment or condo, or applying for a business loan. Your strategy for rebuilding your credit and increasing your score will depend on what caused you to have a low credit score in the first place.
How long does it take for you to improve your credit score? With something like a bankruptcy or judgement (a debt resulting from a lawsuit), there's not much you can do other than wait for the information to fall off your credit report — which can take at least six years.
However, ensuring that your future debt payments are made on time can be a quick win and help you start to improve your credit score, especially if you’re still building up your credit history.
If the cause of the drop is due to false or fraudulent information, reporting the issue to Equifax or TransUnion quickly is crucial. You should also report it immediately to the Canadian Anti-Fraud Centre.
While you can address credit score drops in some situations, prevention is a much more effective overall strategy for maintaining a good credit score. That means paying your credit cards and other debts on time every single month; not applying for multiple credit cards or loans in a short period of time; watching your credit utilization ratio and making sure it doesn't exceed 30 percent; and of course, avoiding bankruptcy.
A certified Credit Counsellor from a not-for-profit credit counselling agency, like Credit Canada, can help you develop the financial skills needed to accomplish all these goals and more. For more advice about credit scores and general financial well-being, you can contact Credit Canada and book a free credit counselling session or debt assessment with one of our Counsellors.