Seeing your credit score go down after paying off debt may seem illogical, but there are likely valid reasons for the drop, including a potential change in your credit mix or in the age of your accounts. Although a lower score may feel like a setback, rest assured the dip is usually temporary.
Let’s take a closer look at some reasons why your credit score dropped after paying off debt and what you can do to help turn things around.
Why Would My Credit Score Drop After Paying Off Debt?
Credit scores are calculated based on a variety of factors. For instance, if you’ve finally paid off a car loan and all of your other debts are from credit cards, your score might drop because you no longer have a diverse credit mix. Creditors and lenders like to see someone who’s been able to manage an array of accounts over time.
But a varied credit mix is only one of the components that make up your credit score. Read on to learn what affects your credit score and how much each factor is impacted when you pay off debt:
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Credit Score Factors
According to FICO™, the credit scoring company used by 90% of the top lenders, your credit score is based on data from five different categories: payment history, credit utilization, length of credit history, credit mix, and new credit applications.
Let’s take a closer look at each one.
Payment History
Showing lenders you can consistently make on-time payments is the top factor in determining your credit score. In fact, under the FICO model, your payment history accounts for the biggest percentage of your credit score (35%).
A late or missing payment can lower your credit score anywhere from 17 to 83 points, depending on where you fall in the credit score range. Generally speaking, the higher your credit score, the greater the impact of a late payment.
Even if you’ve paid off a debt, a delinquent payment can remain on your credit report for up to seven years and negatively affect your credit score.
Credit Utilization
Credit utilization accounts for 30% of your credit score. Your credit utilization is the amount of money you owe versus the amount of credit available to you, and this configuration is called your utilization rate or credit utilization ratio.
Most lenders prefer you to keep your credit utilization ratio below 30%.
Paying off a debt typically improves your credit score, but there are instances when it could have the opposite effect. For example, if you pay off a credit card and then close the account, you may see your score fall. That’s because you now have a lower amount of available credit, which could raise your credit utilization ratio.
Length of Your Credit History
The average age of your credit accounts make up 15% of your credit score. Keeping accounts open — and establishing a track record of timely payments — can help improve your credit score. So if you’re paying off a credit card or other type of revolving debt, consider leaving the account open afterward.
Installment loans, like a personal loan, work a bit differently. When you pay off an installment loan, the account is considered closed. And if you’ve had that account for a long time, your average account age — and your credit score — could drop.
Credit Mix
As previously noted, having a variety of different types of credit, or a credit mix, counts toward your credit score. In fact, it makes up 10% of your FICO score.
Having a combination of revolving credit and installment credit can help boost your credit. But paying off a home, car, or personal loan could change your credit mix, which might cause your score to dip.
New Credit Card Applications
Applying for new credit determines 10% of your credit score. So if, for instance, you decide to open a few new credit cards to help pay off another debt, your score could take a hit. That’s because each time you apply, a hard credit check, or inquiry, is made.
When a lender does a hard credit check, they will pull your credit report from one of the three main credit bureaus: TransUnion, Equifax, and Experian. A hard inquiry can decrease your score by as much as 10 points, so if you’re trying to sign up for multiple credit cards at once, this can have a cascading effect on your score.
How to Pay Off Debt and Help Your Credit Score
There’s no hard and fast rule on how to pay off your debt and build up credit. But it’s always a good idea to make timely, regular payments on balances. Try not to use all your available credit (keep it under 30%). And if you’re overextended, consider reevaluating your purchasing habits with a spending app or other tool.
How Do I Keep My Credit Score From Dropping?
There are other strategies you can take to help prevent your credit score from falling. Here are five to consider:
• Limit applications for new credit, especially if you’re applying for several at one time.
• Try to avoid closing out a credit card account, even if you’ve paid off the balance.
• Review your credit report at least once a year, and dispute any errors. You can get your report for free at AnnualCreditReport.com.
Recommended: Why Did My Credit Score Drop After a Dispute?
How Long Does It Take for Your Credit Score to Improve After Paying Off Debt?
After you make a payment, most large credit issuers and lenders update your account information with the credit bureaus within 30 to 45 days. Smaller credit entities may only report a paid off debt once a quarter, so in that case, it could take several months for your credit score to update.
Ways to Increase Your Credit Score After Paying Off a Loan
In addition to making timely payments, there are several ways to build credit and boost your score.
One tactic is to take the money you were using for the now paid off loan and apply it to one or more of your credit card payments. For example, if you were only making minimum payments, try paying double the minimum each month. If this isn’t possible, even kicking in an extra $10, $20, or $30 can make a difference. Paying double the minimum doesn’t just bring down your balance. It can also lower your credit utilization ratio by increasing the available credit on that card.
Another trick: Contact your card issuer and ask for an increased credit limit so your credit utilization on that card is lower. Or consider becoming an authorized user on a loved one’s credit card account.
Recommended: How Long Does It Take to Build Credit?
How to Get Credit Score Monitoring
There are various ways to check your credit score for free.
• Contact your credit card issuer. Most provide cardholders with complimentary access to their credit score.
• Inquire with your bank. Many financial institutions offer customers either their FICO score or VantageScore for free.
• Sign up with Experian. You can monitor your credit score for free through Experian, one of the three major credit bureaus.
• Download a free money tracking app, which provides you with your score and can alert you to any changes.
The Takeaway
Zeroing out the balance on a loan or credit card can be a big stress reliever, though it may not always provide the credit score boost you were hoping for. Changes in credit mix or account age are among the reasons for a drop.
The good news is, there are ways to help protect your credit score: Pay your bills on time, keep credit card accounts open even after you’ve paid off the balance, and explore credit score monitoring services that alert you to any changes in your score.
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.
FAQ
How long does it take to rebuild credit after paying off debt?
The amount of time it takes to rebuild credit is different for everyone. For some people, it may only take three to six months, while for others it could take years, especially if credit card bills have high balances or are maxed out. Certain factors such as missed payments, which can remain on your credit report for up to seven years, or a declared bankruptcy (which can linger for up to 10 years) can keep your credit score from increasing.
Why does my credit score go down after paying off debt?
Eliminating one debt means you’ve changed your overall credit “portfolio,” which can impact some factors that go into determining your credit score. For instance, if you’ve paid off a car loan and all of your other debts are credit cards, you’ve affected the diversity of your credit mix. As a result, you may see a slight drop in your credit score.
How much will my credit score increase after paying off debt?
There’s no exact number of points your credit score will increase from paying off a debt. However, it’s possible credit scores can increase anywhere between 10 to 50 points after eliminating a credit card debt.
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