There are general guidelines you can follow to build your credit score. But what's often overlooked are the actions you take that actually ding your score, even if you were doing something you thought was positive.
The good news is that many credit score dings are temporary and can be easily recovered. And oftentimes, actions like paying off a loan or applying for a new credit card will benefit you in the long term once you get past the initial fluctuation.
Below, CNBC Select outlines the five ways you may be causing your credit score to suddenly drop — whether you realize it or not.
1. You applied for a new credit card
Card issuers pull your credit report when you apply for a new credit card because they want to see how much of a risk you pose before lending you a line of credit. This credit check is called a hard inquiry, or "hard pull," and temporarily lowers your credit score a few points. Hard inquiries remain on your credit report for two years, but FICO (which most lenders use) only considers inquiries from the last 12 months when calculating your credit score.
But hard inquiries on your credit report aren't necessarily bad when they happen in moderation. After all, applying for credit cards is a great first step in building credit. When you use credit cards correctly — by charging purchases and paying them off in full by the due date — they can help increase your credit score. If you're looking to build credit, consider the Petal® 2 "Cash Back, No Fees" Visa® Credit Card, which offers cash back, or the Capital One Platinum Credit Card that is designed for average credit applicants. (See rates and fees).
To reduce the number of unnecessary hard pulls on your credit report, check if you qualify for a new card by using issuers' preapproval or prequalification offers. These won't guarantee that you'll be approved for the specific credit card, but they'll give you a good idea.
When it comes to actually applying for new credit products, be sure to spread out your credit card applications over time. Only apply for a new credit card every three months, and maybe wait even longer between applications if you have a lower credit score.
2. You charged a large purchase onto your credit card
Credit cards are convenient for making large purchases because you don't need to pay all the money upfront, but leaving a high balance on your card will report a higher credit utilization rate (CUR) to the credit bureaus.
Your utilization rate, or your debt-to-credit ratio, measures how much credit you use compared to much you have available. You want to aim for a low utilization rate because using too much of your available credit limit shows that you pose a financial risk to issuers. Experts recommend keeping your credit utilization below 30%, with some even suggesting below 10% to get the best credit score.
Before you charge a hefty expense onto your credit card, make sure you can pay it off in full before the billing cycle ends. Carrying a high balance on your credit card is not only bad for your credit utilization rate, but it will also incur a whole lot of interest.
3. You missed a credit card payment
Because your payment history is the most important factor that determines your credit score (making up 35% of your FICO score calculation), missing a credit card payment will have an immediate negative effect on your score. Needless to say, lenders and issuers care a lot about whether you've paid your past credit accounts on time because they indicate your risk.
According to FICO data, a 30-day missed payment can drop a fair credit score anywhere from 17 to 37 points and a very good or excellent credit score to drop 63 to 83 points. But a longer, 90-day missed payment drops the same fair score 27 to 47 points and drops the excellent score as much as 113 to 133 points. In other words, the higher your credit score, the greater the negative effect will be.
How quickly your score bounces back after a missed payment varies depending on your credit history and your payment behavior after you miss a payment. If you jump back on track quickly after, it's likely your score will start improving along with your good payment history. A history of on-time payments is vital to a good credit score, and it's even better if you can pay them in full.
4. You paid off a loan
While paying off your credit card debt can increase your credit score, paying off installment debt, such as a mortgage or a student loan, has the opposite effect.
Paying off something like your car loan can actually cause your credit score to fall because it means having one less credit account in your name. Having a mix of credit makes up 10% of your FICO credit score because it's important to show that you can manage different types of debt.
Don't let this prevent you from paying off your loans, however. Being debt-free will help your overall financial health, and it makes no sense to pay unnecessary interest charges over time just to save a few credit score points.
5. You closed your credit card
Closing a credit card account, especially your oldest one, hurts your credit score because it lowers the overall credit limit available to you (remember you want a high limit) and it brings down the overall average age of your accounts. The length of your credit history makes up 15% of your FICO score, which is why experts recommend building credit at a young age. The longer you can show you have had credit, the better for your credit score.
The exception to this is if you are paying for a credit card that you no longer use. In today's world where travel is nearly nonexistent, that may mean closing your luxury travel credit card with a steep annual fee, like the Chase Sapphire Reserve®, which new cardholders pay $550 per year for. It could also mean closing your secured credit card that you paid a deposit for to receive a credit limit, such as with the Capital One Platinum Secured Credit Card; (see rates and fees).
Before closing your card, talk to your issuer and see if you can either downgrade to a no annual fee card or, in the case of a secured card, upgrade to an unsecured credit card. This could help you preserve the credit line so that it doesn't show up as being closed on your report, while getting you a card that's better suited for your needs.
Petal 2 Visa Credit Card issued by WebBank.
