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Making a final debt payment can feel freeing, but it won’t necessarily bump up your credit score. Worse, it can actually cause a dip in your score, as counterintuitive as that may be.
To know why, it’s important to understand the factors that make up your credit score.
Why would my credit score drop after paying off debt?
To be sure, creditors want you to repay them when they lend you money, so it seems reasonable that paying off debt would help your credit score. But that's not exactly how credit formulas work.
Credit utilization — the portion of your credit limits that you are currently using — is a significant factor in credit scores. It is one reason your credit score could drop a little after you pay off debt, particularly if you close the account. Having low credit utilization (30% or less, and the lower the better) is good.
Other factors that credit-scoring formulas take into account could also be responsible for a drop:
The average age of all your open accounts. The most commonly used score, FICO, continues to include the age of your closed accounts in its scores. But rival VantageScore may not. If you paid off a car loan, mortgage or other loan and closed it out, that could reduce your age of accounts in VantageScore's calculations. That's also true if you paid off a credit card account and closed it.
The types, or "mix," of credit you have. Scores reward you for having both installment accounts (with set payments over a specific time, like a loan) and revolving accounts (with varying payments and no set end date, such as credit cards).
Let's say you just made the final payment on your car loan. Your payment history is perfect and you keep credit card balances low. But now you have one less account, and if all your remaining open accounts are credit cards, that hurts your credit mix. You may see a score dip — even though you did exactly what you agreed to do by paying off the loan.
The same is true of credit cards. Usually, paying off a credit card helps lower your credit utilization because your remaining balances are a smaller percentage of your overall credit limit. But if you close the account you just paid off, you lose that account's credit limit and now your other balances represent a greater percentage of your total limit.
It's smart to keep on top of the factors that influence your credit score, and it's easy to automate. NerdWallet can show you where you stand with credit score factors and how your score is responding. NerdWallet updates your credit information weekly.
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Focusing on credit card debt first can help your budget because cards tend to have higher interest rates than installment loans. It also helps your score by lowering your credit utilization.
Credit utilization is calculated both on a per-card and overall basis. If you have any credit cards that are anywhere close to their limits, make it a priority to lower those balances to no more than 30% of your limit — and lower is better.
Keep these credit-building habits in mind:
Pay on time, every time.Late payments can seriously damage credit.
Keep credit cards open unless you have a compelling reason for closing them, such as an annual fee or poor customer service. When you close an account, it can reduce your average account age. It also cuts your available credit, which sends utilization up.
Use credit lightly. If you no longer love the card, consider putting a small, recurring charge on it, and putting it on autopay. That way you don't miss paying the bill, and the issuer won’t close the card because of inactivity.
Take an overall view of installment loans. Don't keep an installment loan open just to avoid score damage — you're costing yourself unnecessary interest.
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How do I keep my credit score from dropping?
Once you’ve gotten your balances to zero, here’s how to guard your credit.
Make it easier to pay on time. Set up reminders to pay bills. You can set up calendar reminders, or get emails or text alerts from most issuers.
Watch for credit report errors. Any attempt to build your credit will be fruitless if the data going into your scores is wrong.
You can get free credit report information two ways: Some personal finance websites and credit card issuers offer report information. And you’re entitled to a free report directly from the credit bureaus.
The reports you can get weekly from the three credit bureaus can run to dozens of pages.
If you see an error, dispute it. Someone else’s file mixed up with yours or identity theft could potentially — and unfairly — hurt your score. The sooner you address that, the better.
Don’t apply for multiple credit products in a short time. Opening a new credit account lowers the average age of your credit accounts and involves a hard inquiry, which can result in a small, temporary drop in your score. If you can, wait at least six months between credit applications, and do your credit card research before you apply.
Practice patience. Sometimes the best thing you can do for your credit is wait. A combination of patience and good habits will help any credit score bounce back. Most credit missteps fall off your credit records in seven years.
Your payment history is perfect and you keep credit card balances low. But now you have one less account, and if all your remaining open accounts are credit cards, that hurts your credit mix. You may see a score dip — even though you did exactly what you agreed to do by paying off the loan.
It's possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt. Paying off debt might lower your credit scores if removing the debt affects certain factors like your credit mix, the length of your credit history or your credit utilization ratio.
Card issuers frequently change credit lines for a variety of reasons, which may or may not have anything to do with the way you handled the account. Lowering credit lines is simply a strategy to mitigate risk, and an issuer may take that action when necessary.
It can take weeks or even days for you to notice a change in your credit score. If you have recently paid off a debt, wait for at least 30 to 45 days to see your credit score go up. Will it be beneficial for my credit score if I pay off a debt? Your payment history will not be removed after you pay off a debt.
Various weighted factors mean that even with no credit, your credit score could still be low because the length of your credit history or credit mix, for example, could also be low.
For some credit scoring models, paying off collection accounts may improve credit scores. FICO® Score 9, FICO Score 10, VantageScore® 3.0 and VantageScore 4.0 credit scoring models penalize unpaid collection accounts. Paying off collection accounts may help improve these scores.
Call your credit card issuer's customer service department and ask why your credit limit was decreased. Then, ask if it can increase your credit limit to the original credit limit amount.
One of the most common reasons for a decreased credit score is a missed payment. Your payment history accounts for 35% of your FICO Score and around 40% of your VantageScore. If you allow a payment to go 30 days past due, the delinquency will be reported to the major credit bureaus, resulting in a credit score drop.
Although your spending habits and total debt haven't changed, the lower credit limit changes the ration, and this higher debt-to-credit ratio could still have a substantial impact on your credit scores.
If you're close to maxing out your credit cards, your credit score could jump 10 points or more when you pay off credit card balances completely. If you haven't used most of your available credit, you might only gain a few points when you pay off credit card debt. Yes, even if you pay off the cards entirely.
It's a good idea to pay off your credit card balance in full whenever you're able. Carrying a monthly credit card balance can cost you in interest and increase your credit utilization rate, which is one factor used to calculate your credit scores.
The minimum credit score needed for most mortgages is typically around 620. However, government-backed mortgages like Federal Housing Administration (FHA) loans typically have lower credit requirements than conventional fixed-rate loans and adjustable-rate mortgages (ARMs).
Credit scores can drop due to a variety of reasons, including late or missed payments, changes to your credit utilization rate, a change in your credit mix, closing older accounts (which may shorten your length of credit history overall), or applying for new credit accounts.
Financial experts agree that you should generally invest your extra cash rather than accelerate paying off low-interest debt, but still some people place immeasurable value on being debt-free or owning a debt-free home.
Your credit score is a major factor in whether you'll be approved for a car loan. Some lenders use specialized credit scores, such as a FICO Auto Score. In general, you'll need at least prime credit, meaning a credit score of 661 or up, to get a loan at a good interest rate.
Payment history has the biggest impact on your score, followed by the amounts owed on your debt accounts and the length of your credit history. There are other elements, too, that could affect your credit scores, such as inaccurate information on your credit report.
In fact, some consumers may even see their credit scores rise as much as 100 points in 30 days. Steps you can take to raise your credit score quickly include: Lower your credit utilization rate. Ask for late payment forgiveness.
Why did your new mortgage drop your credit score by 100 points? Your new mortgage can cause your score to drop because it's a new account and likely a significant debt added to your credit history. Once you establish a positive payment history, your score will likely increase.
Introduction: My name is Merrill Bechtelar CPA, I am a clean, agreeable, glorious, magnificent, witty, enchanting, comfortable person who loves writing and wants to share my knowledge and understanding with you.
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