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
The Reason Behind The Drop
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.
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.
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.
Second, 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.
Third, 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.
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.
Amit Gupta is the founder of National Planning Cycles, a company that helps startups, individuals, and small businesses with their financial planning. He has a vast amount of experience in the finance sector, having managed Google Play accounts for some of the world’s most successful unicorns. Amit is an expert in his field, and he uses his knowledge to help others achieve their individual goals.