Most Americans don’t realize how much their daily life is affected by their credit score. Almost everyone is aware that their credit score is used when they want to finance a major purchase, but it goes far beyond this. Your credit score is a determining factor in most auto, renters, or homeowners insurance rates. Most rental car agencies also use credit scoring to determine rental eligibility, deposit amount, and other rental factors. These are just a couple of “hidden” examples. Your credit score is continually being looked at, which is why it’s ever more important to maximize the score you have.
During a career in banking and credit, I’ve looked at countless credit reports — and sometimes it’s understandable when a score has decreased. The problem is: a lot of financial modeling is completely computerized to the point where only the score is being looked at. If you have a credit score of 690 or higher, you probably don’t need to be overly concerned with it affecting you negatively. However if your credit score is less than 690, then any dips could cost you significantly.
If Your Credit Score Drops For Legitimate Reasons
There are some “okay” reasons your credit score may decrease. Perhaps you’ve just replaced an older, less reliable car with a new, but affordable, car. That inquiry and the new loan will decrease your credit score in the short term. The same can be said for a home purchase or a debt consolidation loan, which lowers your overall payment and provides a reasonable path to eliminating your total debt.
It’s important for you to understand what has happened to your score and why, so that you can communicate this when you need to. If your credit score has decreased due to a legitimate reason and you have the opportunity to discuss it with lender, insurance company, etc, here are some conversation tips:
- Having a single medical collection (or two) is actually starting to be ignored by credit organizations, due to the fact many medical bills are sent to collection agencies without the knowledge of the person responsible. These credit agencies have realized billing takes time between health insurance companies and health care providers. By the time both parties have dealt with the billing, a large amount of time has passed and the bill has been routed to collections through an automatic process without your knowledge or notification. This can be a discussion point.
- If there are no late payments, but your credit score has decreased due to a major purchase, this can be a discussion point. Was it a responsible purchase which fits into an appropriate DTI (debt to income) of 40% or less? Was it to replace a car that’s needed for commuting, or was it just to buy a new toy (auto/boat/etc)? Was it a home purchase, and how does that compare to previous rent payments?
What Issues Do I Need To Be Concerned About?
On the other hand, here are some credit issues which you will not be able to explain away, and that a lender will take very seriously:
- Adding additional available credit without a legitimate reason for doing so. As an example – let’s say a cashier offers you 10% off today if you apply for their credit card. If you aren’t approved, it’s probably due to your score and/or your current amount of debt. If this is the case, you’ve simply further lowered your score through a preventable event. If you are approved, you’ve added another item to your credit report: It’s new, so it hurts your score since you have no proven history of using it responsibly; and it’s additional credit available and whether you’ve used it or not, a percentage of the available balance is used to determine your future credit decisions.
- Owing more than 50% (or sometimes even 25%) of the credit card available balance. If you haven’t responsibly paid it down and are only making payments, it’s an indication you didn’t plan for the purchases and aren’t budgeting well. The caveat here being, if your credit report indicates you normally have a low balance, you have a reason for the higher balance and can show you have the money to pay it back down during the month.
Your credit score affects your budget, whether you’re shopping for a new loan or not. Because of this, do what you can to understand it. You’re entitled by Federal law to a free copy of each of your credit reports every 12 months. Take the time to obtain a copy of all three different credit bureaus; Experian, Equifax and TransUnion. And then place a reminder on your calendar for next year. To obtain a truly free copy, go to http://www.annualcreditreport.com/. Remember to request all three reports because there are sometimes differences or errors from bureau to bureau.
(photo from GotCredit via Creative Commons)