Are you thinking about why my Credit Score dropped after paying off debt? Keep reading!
If you’ve ever paid off a large chunk of debt, only to see your credit score take a dive, you’re not alone.
While it may seem counterintuitive, paying off debt can actually lower your credit score if you owe money on multiple accounts.
But why does this occur, and can you do anything to avoid it? Here’s what you need to know
- Try not to increase your credit card balances. This will help reduce your credit utilization ratio.
- Closing too many accounts at once can hurt your credit score.
- If you pay off a debt that you’ve had for a long time, it can hurt your score.
The Reason Behind The Drop In Credit Score
When you pay off debt, your credit utilization ratio-the amount of debt you owe compared to your credit limit-decreases.
This is generally a good thing, as it’s a sign that you’re using less of your available credit.
However, if you have multiple lines of credit, such as credit cards, a car loan, and a mortgage, and you pay off one of them in full, your credit utilization ratio on the other accounts will increase.
For example, let’s say you own 2 credit cards with limits of $5,000 each. One has $2,500, and the other has a balance of $0.
Your total debt is $2,500, and your credit limit is $10,000, so your credit utilization ratio is 25%.
Let’s say you pay off the card with the $0 balance. Your total debt is still $2,500, but your credit limit is now $5,000, so your credit utilization ratio jumps to 50%.
This increase in your credit utilization ratio can hurt your credit score because it’s a sign that you’re using your available credit too much.
Some other factors that can contribute to a drop in your credit score after paying off debt include:
- Your Credit Mix: If you have various types of debt, such as revolving debt (credit cards) and installment debt (car loans), and you pay off one type of debt, it can impact your credit score. The same is true if you close an account.
- The Age of Your Accounts: If you have a long credit use history, it can benefit your credit score. So if you pay off a debt that you’ve had for a long time, it can hurt your score. 1
Here’s what reddit users know:
My credit score dropped 28 points after paying off my card… why?
by u/etherealexit in CRedit
What You Can Do To Avoid The Drop?
If you’re planning to pay off a large chunk of debt, there are a few things you can do to avoid seeing your credit score take a hit.
- Pay debt with the higher interest rate first: First, consider starting by paying off the debt with the highest interest rate. This will potentially save you money and may help keep your credit score from taking too big of a hit.
- Do not increase your credit card balances: Try not to increase your credit card balances. This will help reduce your credit utilization ratio and may help prevent your score from dropping too much.
- Don’t close all your accounts at once: If you’re planning to close any accounts after paying off the debt, be sure to do so gradually. Closing too many accounts at once can hurt your credit score. 2
Ways To Improve Your Credit Score After Paying Off a Loan
The FICO score comprises of five categories. payment history (35%), length of credit history (15%), new credit (10%), credit mix (10%) and credit utilization/amounts owed (30%).
To improve your credit score after paying off a loan, here’s what you can do:
Diversify your credit portfolio
Credit card debt is a revolving debt while installment loans are have a specific repayment period.
Installment loans does not damage your credit score as much as a credit card debt or any other lines of credit does.
This credit score category is called credit mix and Creditors like to see a mix of different types of loan on your credit portfolio.
So for example if you pay off your installament loans and have only credit loan left then this will increase your credit score.
Pay on time
The credit score is heavily affected by how often you make your payments on time. Make sure you keep making your minimum monthly payments on time always.
Defaulting on loans or missing out on payments can plummet your credit score a lot.
Work on your credit utilization ratio
By keeping your credit utilization ratio low you can increase your credit score. Credit utilization ratio between 10-30% is considered a sweet spot.
To obtain credit utilization ratio, divide your total balances with total credit limit on all of your cards. 3
Paying off debt can be a great financial move, but it’s important to be aware of the potential impact on your credit score.
By taking steps to avoid a drop in your score, you can keep your credit history strong and maintain a good credit standing.
How long will it take for my credit score to change after I have repaid my debt?
The three nationwide CRAs receive information from your lenders and creditors every 30-45 days.
So it can take more than a month to see changes in your credit score if you have recently paid off a debt. 4
What is considered a good credit score?
Although this could vary based on different credit models, ideally credit score between 580 to 669 is considered fair, between 670 to 739 is considered good, 740 to 799 is considered good very good, and lastly, above 800 is excellent.
What are the biggest mistakes that one makes while paying off debts?
Here are the four biggest mistakes to avoid while repaying your debts:
- Working on debt repayment without having an emergency fund
- Not having the plan to payoff
- Spreading your money too much
- Not keeping track of your progress
Traci is a highly experienced debt resolution expert with over 8 years of expertise in helping people become debt-free through various debt relief programs. As a former employee of a well-known debt relief company, she possesses exceptional knowledge and skills to take care of debt-related issues.
When not writing about debt, Traci can be found conducting in-depth research on the latest developments in the industry to ensure that she stays up-to-date with the latest trends and strategies.
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