Credit Score Analysis | Should a Credit Score Drop Cause You to Adjust Your Strategy?

When I talk with newbies about signing up for credit cards to get free/cheap/discounted travel, one of the hesitancies is the impact on a person’s credit score.  Since my quarterly FICO score was just updated, I want to use my own score to help us analyze what is happening, and discover the important lessons for you.

Over the last four months, I’ve noticed the largest credit score drop on my credit score.

So, does this mean I’m going to drop out of the points and mileage game?

Nope!

Here’s the first thing we each need to know about credit scores.  Drops and increases in your credit score only functionally impact us when they move us to a different category in the eyes of a lender.  Look at the chart below as an example (data taken from my account with myfico.com):

ficorates

With my score dropping to the low 750’s, I may not be eligible for the lowest APR on my mortgage.  That might be a reason for concern if I planned to get a mortgage or refinance in the next few months.  But I’m not, so there is no actual or functional impact here.

Even look at how my score impacts my ability to get the best rate on an auto loan (below).  It doesn’t.  However, I also won’t  be getting an auto loan any time soon (I pay cash for cars), so the drop doesn’t impact me one single bit.

ficoloan

Analysis of What Caused the Credit Score Drop

Even though there is no functional impact, I decided it would be valuable to analyze the score so we could learn a few important lessons about credit scores and the impact of signing up for multiple credit cards.

Here’s what’s happened lately with my credit score:

From Credit Karma:

creditkarma

 

My official FICO score dropped 25 points in the last 4 months.

I’ll piece together the reasons and share why I don’t plan to strategically change how I do my credit card applications (signing up only when there is a very generous bonus).

The Credit Score Perfect Storm

First, the following explains how a credit score is calculated:

fico

Image credit to MyFico.

So why did my score drop so much?

ficoscore

1.  Larger than normal account balances

Over the last few months, we’ve had more than our fair share of larger purchases.  The purchases included things like plane tickets, dentist visits, eye examinations, glasses, and such.

The result is that we’ve had higher credit card balances.  We don’t keep a balance; it’s just that our current charges show up on our credit report as a balance.

When our spending goes back to normal, the account balances will once again decrease.

2.  Closed two accounts within the last couple of months

The biggest impact of closing the accounts is that my credit card utilization rate increased 54% since the month before.

It looks like we’re using a lot more of our total credit because of point #1 and #2 combined.

Since I closed two accounts, I lost $6,000 worth of credit.

MyFico explains the following factors impact the Amounts Owed category:

    • Amount owing on accounts
    • Amount owing on specific types of accounts
    • Lack of a specific type of balance, in some cases
    • Number of accounts with balances
    • Proportion of credit lines used (proportion of balances to total credit limits on certain types of revolving accounts)
    • Proportion of installment loan amounts still owing (proportion of balance to original loan amount on certain types of installment loans)

Let’s say I had $15,000 worth of available credit and a balance of $2,000.  That means I’d be using 13% of my available credit.  However, I then have a balance of $5,000 and an available credit of $9,000 (since accounts have been closed).  Now it would show up that I’m using 55% of my available credit.

Of course, I always anticipate my “new credit” section to be less than stellar because I do tend to get new credit cards.  However, that only represents 10% of my credit score.

Thus, even though I lost 25 points in four months, I’m not concerned, and I’m not planning on changing my strategy.  The low score was the result of a couple of unique situations that won’t be soon repeated.

This now ends your FICO 101 lesson.

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