Smart Money Podcast: ‘Why Did My Credit Scores Suddenly Drop?’

Sean Pyles: Hello and welcome to the NerdWallet Smart Money Podcast, where we answer your money questions in 15 minutes or less. I'm your host, Sean Pyles.

Liz Weston: And I'm Liz Weston. As always, be sure to send us your money questions. Call or text us at 901-730-6373. That's 901-730-NERD. Or write us or send us your voicemails to [email protected] to be featured on a future episode.

Sean: Let's get to this episode's question from Kirsten. Kirsten says, "My TransUnion score dropped 16 points. My Experian score dropped 18 points, and my Equifax score dropped 20 points. I don't understand why. There are no new accounts. There are no new inquiries. There are no late payments. My credit usage went from 6% to 3%. One of my cards increased my credit line by $10,000. All of these are good things that are supposed to help your score, so I don't understand why my scores dropped so drastically. Any ideas?"

Liz: Unexplained credit score drops can be so frustrating. There isn't always a clear answer, unfortunately. But sometimes there are enough clues that we can figure out what's happening, and I think that might be the case here.

Sean: As nerdy as this sounds, questions like this can be kind of a fun puzzle because credit scores are a bit of a black box in the personal finance world, and navigating them can be really tricky. There are just so many factors that can impact your score at any given moment, so it is always a bit of a mystery to figure out why a score changed. To help Kirsten get to the bottom of this, on this episode of the NerdWallet SmartMoney Podcast, Liz and I are going to give you the insider info on how a credit score works, what might lead to a big unexpected drop, and then give you some tips on how you can recover from one. Let's unravel this mystery.

We should probably start with a few basics about what credit scores are and how they work. Concocted deep in the secret lairs of the credit scoring companies, credit scores are the three digit numbers that are supposed to predict how likely you are to default or stop paying your bills. Credit scores determine what loans and credit cards you can get and their interest rates, but they're also used by landlords to evaluate applicants and by insurers to set premiums. Cell phone companies and utilities use them, as well. So for better or worse, we're stuck with them, and they're really important to our financial lives.

Liz: Yes, they are. And while most personal finance is not rocket science, credit scores kind of come close. The formulas are complex, and they're not well understood. The most important things to remember are: One, you don't have one score, you have many. Two, they're based on the information in your credit reports at the three credit bureaus. And three, they change all the time because the underlying information is always changing.

There's something else about credit scores that people really need to know, which is they are multi-variate. Now, that's a big word, but what it means basically is that something that really affects your score might not affect mine at all. The same action can have different outcomes depending on the information in your credit report. So if you have a short credit history, for example, a minor change could have a big difference. If you have a longer one, it can take more to get that needle moving either one way or the other. So that's something to keep in mind, that what affects your score may not be the same as what affects your neighbor's score. So you can't draw huge conclusions based on a small number of changes or a small amount of information.

Sean: We are not all created equal in the eyes of the credit score companies, basically.

Liz: That's perfect. Yes, exactly.

Sean: If you haven't gathered this already, the credit scoring industry is intentionally complex and keeps their secrets really well guarded. Just ask my colleagues at NerdWallet who write about this stuff. But for the purposes of answering Kirsten's question, back to how things work. That part about having many scores is important because sometimes people don't understand that there isn't just one score or one scoring formula. FICO scores are the ones most people have heard about, but lenders also use VantageScores.

Liz: And it gets even more complicated because the formulas get updated over time. So VantageScore 3, for example, is probably the most widely used VantageScore now, but there's also a VantageScore 4, and obviously there's previous versions of the VantageScore. The most-used FICO score is FICO 8, but mortgage lenders use FICOs that are much older. Plus there's a newer one, FICO 9, and soon there will be a FICO 10.

Sean: A lot to keep track of. But I think that a good analogy is that they're kind of like computer operating systems. There's Windows and Mac OS and all of their various updates over the years. And also like operating systems, it's on the lenders to upgrade to the newest formulas if they want to. And while there are some early adopters, it can take years for most lenders to update, much like how my mom is still using iOS 10 and can't see any of the new emojis that I'm texting her.

Liz: And eventually we hope they update, but maybe not. So what I mentioned about FICO 8 being the most used score, that one came out in 2009, it's already a decade old. So this adoption thing can take a while. Also, lenders sometimes use formulas that are customized for their industry, so there are FICO scores specifically for auto lenders and for credit cards. And those aren't even on the same scale as other credit scores. You might have heard that credit scores are on like a 300 to 850 scale, and most of them are, but those auto scores and the credit card scores are on a completely different scale.

Sean: Yeah. That's all to say these credit scoring formulas are kind of moving targets and can be really tricky to pin down. But fortunately, the factors that affect scores tend to be more or less consistent, even if how they're weighted can change from one company or one update to the next.

Liz: Yeah, that is a bit of good news because they all generally use the same major factors, even if the minor factors might be different. So the most important factors with credit scores are your payment history, have you been paying your bills on time? And your utilization, or how much of your available credit you're using.

Sean: Yeah, those two, especially utilization can be the one that leads to the biggest changes month over month. At NerdWallet, we're big nerds about this stuff. We actually track internally, a group of us, how a 1% change can lead to a certain drop in your credit score. And person to person, the same change can have really different impacts. It's pretty fascinating. But as you said, payment history and utilization are the two biggies. But length of your credit history, or how long you've had credit for, and your mix of accounts like credit cards, student loans, auto loans, and any recent applications for new credit also affect your score but to lesser degrees. But with all of these things floating in the air here, I'm slightly worried we have made Kirsten even more perplexed about what's happening with her score. So for the purposes of her question, how can all this info help her figure out what happened to her score?

Liz: OK. The most important thing to remember is that you need to compare apples to apples. So you shouldn't be comparing a VantageScore to a FICO, or different types of FICOs to each other, or even FICOs at different bureaus. Instead, you need to look at the same type of score for the same bureau if you want to watch changes over time. And I'm going to put a pitch here for NerdWallet score, we have a VantageScore 3 from TransUnion, and that's a good score to just let her monitor what's going on with her account.

Using the same score over a period of time can really help you get a good gauge for fluctuations in your score, and also make sure that you are getting that apples-to-apples comparison. Otherwise, it's really easy to fret about why your FICO is a certain number and your VantageScore is a different number, when it may have to do more with them than with you.

Sean: So for the sake of Kirsten’s situation, let's assume that she is comparing apples to apples, and she's looking at the same type of score at each of the bureaus, and they all dropped roughly the same amount without any big activity on her end. How can she figure out what happened here?

Liz: OK, she says there were no late payments, which makes sense because a late payment would have a much bigger impact on her score. They would drop a lot more than 20 points, it could drop as much as a hundred points. So that's huge, and that's why you want to pay your bills on time. A lot of times a drop like this has to do with credit utilization, which basically again means how much of your available credit you're using, and the scoring formulas are particularly sensitive to how much of your revolving credit you're using. That's your credit on your credit cards. So if your balances start to inch up, your scores can drop.

In this case, she said, okay, her utilization went down. So that's probably not the culprit, but I would put a pitch in here for her to take a look at each individual credit card. Because even though her overall credit utilization may have gone down, one of her cards may have popped up. So that could be the culprit here.

Sean: Right. So her utilization went down and also her credit line increased by $10,000, which you'd think would be good for her utilization, not bad for her scores. So if anything, you'd think that would have made her scores go up.

Liz: Exactly. So I'm thinking if there is a credit utilization issue, it may be that problem with having one credit card that she's racked up a little bit more debt or racked up a bigger balance on. So that's the first place that I'd look.

My next go-to question would be, did you open any credit cards or apply for a loan? Because I noticed my scores all dropped by about 20 points when we refinanced a mortgage. Usually the drop isn't that great, it's like five points or less. But in this case she said she didn't open anything new.

Sean: She didn't say whether she closed any accounts though. Closing credit card accounts can hurt your score since it does reduce your overall available credit. Also, paying off installment loans like an auto loan or a mortgage can have the same effect. Sometimes a lender might stop reporting a closed account to the credit bureaus, and that might have an effect on your scores too.

Liz: And if you're just looking at your scores and not looking at the underlying credit reports, it can be hard to see what's actually changed. Another quirk of the credit scoring systems is that your scores can drop a bit if something bad falls off your credit reports.

Sean: Wait, really? That makes it really seem like these companies are setting us up to fail.

Liz: Remember that the scores are designed for lenders, not for consumers. There are reasons why they act the way they do, but they're not necessarily consumer friendly. So the scoring formulas divide us up by the worst thing on our credit reports, if we have any of those negatives. So we're compared to other people who have the same bad thing. If you've been through a bankruptcy, and it's still on your credit report, you're going to be compared to other people who have a bankruptcy. If the worst thing is a late payment, again, you'll be with the people that that's the worst thing on their credit reports. We might look pretty good compared to the other people in our group, but when that bad thing falls off, we might not look so good compared to the people in the next group when we move up. Does that make sense?

Sean: Kind of counterintuitive here. You've moved into a new group but now you're on the low end of this new group. And of course, all of this is internal to the credit scoring companies and we can't even see what group we're in.

Liz: Yep. Although I do have to say that this seems to happen a lot less than it used to. I think the scoring companies have gotten better about smoothing that transition, so we don't see those big score drops when you move from one scorecard to the next.

Sean: So here's the real question. How worried should Kirsten be?

Liz: At this point, I don't think she should be super worried. These drops can feel like a big deal, but sometimes they're just noise. I'd wait and see what happens next month, I'll bet they bounce back.

Sean: And if they don't, she can always come to NerdWallet to learn about building and rebuilding credit. And to that end, let's fire off a couple of our quick tips for helping to raise your credit score fast. I'll go first. If you want to raise your score, focus on your utilization. Try making multiple payments a month on your credit card to keep that percentage low.

Liz: And here's a favorite of mine, credit builder loans. If you're new to credit or trying to rebuild your credit, these loans can help you do that and often help you build an emergency fund at the same time. Check your local credit unions, and there's also a credit builder loan that's online.

Sean: Always a good one. Well Kirsten, I think the lesson of today is that credit scores are a lot more complicated and frustrating than they have any right to be. So don't sweat random drops, and focus on the behaviors that can keep your score high and healthy.

Liz: All right, with that, let's get to our takeaway tips. First, compare apples to apples. Make sure you're tracking the same score from the same bureau.

Sean: Second, pay on time and pay attention to your credit utilization. The less of your available credit that you use, the better. 30% or less is good, 20% or less is even better, 10% or less is best.

Liz: And finally, don't sweat the small changes, or even some of the larger ones. Your scores change all the time as the underlying information in your credit reports changes. Trends over time matter a lot more than those month-to-month changes.

Sean: And that is all we have for this episode. Do you have a money question of your own? Turn to the nerds and call or text us your questions at 901-730-6373, that's 901-730-NERD. You can also email us at [email protected]. Also, visit nerdwallet.com/podcast for more info on this episode. And remember to subscribe, rate and review us wherever you're getting this podcast.