It may come as a surprise, but sometimes your credit score drops after you pay off a loan or credit card debt. This happens because paying off debt can impact several factors that make up your credit score. For example, it might change your credit mix, shorten your credit history, or impact your credit utilization ratio.
If you’re wondering why your credit score dropped 40 points after paying off debt, here are some potential reasons to consider.
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Why Would My Credit Score Drop 40 Points After Paying Off Debt?
Paying off your debt is a big win and usually boosts your credit score. But sometimes, you might see a dip. To understand why, it’s important to know how your score is calculated.
Information from the three major credit bureaus — Equifax, TransUnion, and Experian — comes together to create your credit score. The bureaus gather details about your loans, credit cards, and other debts. Your credit score is calculated using a formula that measures how reliable you are at making payments. Lenders use this score to decide if they should give you credit.
Recommended: How Long Does It Take to Build Credit?
Credit Score Factors
Although there are many ways to calculate your creditworthiness, here are some common factors that may affect your credit score after you pay off your debt.
Payment History
Payment history makes up 35% of your FICO credit score and is the most important factor. So while late or missing credit card payments might not seem significant at the time, they could bring down your overall score.
If you need help keeping track of bills, consider a tool like a money tracker app. It allows you to spot upcoming bills, create budgets, and monitor your credit score.
Credit Utilization
Your credit card utilization ratio — or the amount of available credit you’re using — makes up 30% of your credit score, so it’s worth monitoring.
Here’s how it works: If you have $10,000 in available credit and a $5,000 credit card balance, your credit utilization ratio is 50%. Usually, credit bureaus and lenders want to see a utilization ratio under 30%.
When you pay off your debt and close the account, your total available credit decreases and your credit utilization ratio increases. This, in turn, can cause your credit score to dip.
Length of Your Credit History
Your credit reports show how long your credit accounts have been open. Having a longer credit history can improve your credit score, albeit not to the extent other factors can. (It makes up 15% of your credit score.) On the flip side, if you close an old account, you shorten your credit history — which can potentially lower your score.
Credit Mix
The variety of your credit accounts — like personal loans, credit cards, and mortgages — is 10% of your credit score. And managing different kinds of credit can help improve it. Paying off a specific type of credit, such as a car loan or mortgage, can have the opposite effect, as it reduces the diversity of your credit mix.
New Credit Applications
When you apply for a new line of credit, lenders check your credit report to determine the risk of lending you money. This check, known as a hard inquiry or “hard pull,” can drop your credit score by a few points for a short time, though it stays on your report for two years.
But keep in mind, when calculating your score, FICO, the scoring model most lenders use, only looks at credit pulls from the past 12 months. And new credit only makes up 10% of your credit score.
Recommended: What Is a FICO Score?
How to Pay Off Debt and Help Your Credit Score
Paying off debt may lead to a temporary dip in your credit score, but its benefits far outweigh any drawbacks. In fact, there are steps you can take build your credit as you whittle down your debt load:
• Make on-time payments: Always make payments on time, whether it’s your credit card balance or mortgage. Punctual payments positively impact your score the most.
• Prioritize high-interest debt: Pay off credit cards with the highest interest rates first to reduce debt risk.
• Pay off cards with a low credit limit: This can help keep your debt-to-credit ratio in check.
• Keep credit utilization low: Aim to use less than 10% — and no more than 30% — of your available credit.
• Clear small balances on multiple cards: Having zero balances on more cards is better for your score.
• Pay off past-due bills: Prioritize the most recent ones. This shows new lenders that you’ve settled your debts.
How Long Does It Take for Your Credit Score to Improve After Paying Off Debt?
Luckily, a drop in your credit score is generally brief. After you pay off your debt, your score should bounce back within a month or two because credit bureaus typically update your credit information every 30 to 45 days.
You can check your credit score without paying. If it doesn’t improve right away, don’t worry. The paid-off debt will stay on your credit report for up to 10 years. If you made payments on time, this positive history can help boost your credit score in the long run.
Ways to Increase Your Credit Score After Paying Off a Loan
Once your debt is settled, you may want to turn your focus to boosting your credit score. Some steps you may have taken as you paid down the debt will serve you well at this point, such as making on-time payments and keeping credit utilization low. But there are other strategies that can help:
• Build a long credit history: Keep older accounts open so you can build a long history of responsible credit use. The longer your history of on-time payments, the better your score may be.
• Apply for credit sparingly: Only apply for new lines of credit when needed. Too many applications in a short period can negatively impact your score.
• Review your credit reports: Regularly review your credit reports for any errors or inaccuracies. If you spot anything out of the normal, make sure to dispute any mistakes. This way, you can ensure your score reflects accurate information.
How to Get Credit Score Monitoring
Using a credit monitoring service can help you keep tabs on your credit score. These services notify you when there are changes to your credit reports, which can help you catch any suspicious activity. While comprehensive monitoring services are available, there are ways to monitor it yourself:
• Ask for a free copy of your credit report: You’re entitled to a free credit report every year from each of the three credit bureaus. Visit AnnualCreditReport.com to get started.
• Check for complimentary credit monitoring: Some accounts offer free credit score monitoring. Call your bank or credit card company to see if you qualify.
• Freeze your credit reports: If you suspect a data breach or theft of your Social Security number, consider freezing your credit report. This restricts access to your credit information, stopping thieves from opening new accounts in your name. Note that freezing or unfreezing your credit is free and doesn’t affect your credit score.
• Set up fraud alerts: You can place a fraud alert on your credit report if you think you’re a fraud or identity theft victim. Creditors will verify your identity by calling you when a credit application is made. It’s free to request and lasts for one year without affecting your credit score.
The Takeaway
There are many reasons why your credit score dropped 40 points after paying off debt. You may see a temporary dip in your credit score due to changes in your credit mix, history length, and utilization ratio.
To help boost your score, make on-time payments, use less credit, maintain old accounts, apply for new credit sparingly, and regularly check for errors in your credit reports. These habits can help you maintain a strong credit score. And if you need help managing your finances as you pay off debt, consider enlisting the help of a spending app.
Take control of your finances with SoFi. With our financial insights and credit score monitoring tools, you can view all of your accounts in one convenient dashboard. From there, you can see your various balances, spending breakdowns, and credit score. Plus you can easily set up budgets and discover valuable financial insights — all at no cost.
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FAQ
How long does it take for a credit score to update after paying off debt?
You can expect your credit score to update within a month or two as long as you continue practicing good credit habits like making on-time payments. Credit bureaus usually refresh your information every 30 to 45 days.
Why is my credit score going down even though I pay on time?
Paying on time is just one part of your credit score. Other factors, like how much credit you’re using or the length of your credit history, can also cause your score to drop, even if you don’t miss any payments.
How to increase credit score after paying off debt?
To keep your credit score strong after paying off debt, follow a few key tips. For example, always make your payments on time, avoid using too much of your available credit, and apply for new credit only when you really need it. Also, review your credit score regularly so you can spot discrepancies.
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