It is smart and rewarding to pay off debt, so you may be startled to see your credit score drop after making a payment. Given that credit ratings are based on a range of criteria, the decline might have occurred for a number of reasons. After paying off debt, the most frequent reasons for a decline in credit score are a decrease in the average age of your accounts, a change in the types of credit you have, or an increase in your total utilization.
However, it is crucial to remember that credit score decreases caused by debt repayment are often temporary. In general, the advantages of eliminating debt exceed the disadvantages of a lower credit score. If your debt has a high-interest rate, the amount you owe will continue to increase over time; thus, lowering the balance or paying it off on whole might save you a substantial amount of money.
Your Account’s Average Age May Have Been Reduced.
The duration of your credit history, which includes the average age of your accounts, contributes to your credit score.
If you pay off and cancel your oldest account, the average age of your accounts will fall, which might lower your credit score.
Although closed accounts remain on your credit record for seven to ten years after they are closed, they are evaluated differently than active ones.
Your credit history and average account age will likely rise over time, thus the decrease caused by paying off debt is likely temporary.
You May Now Have Fewer Credit Types.
The sorts of accounts shown on your credit report are another component in determining your credit score. In general, the credit agencies who record your credit history want to see that you use many forms of credit responsibly.
Your credit report may show a couple of credit cards and an auto loan, for instance. If you pay off and end your auto loan, your credit mix will become less diverse, since it would consist solely of credit cards. This may result in a temporary reduction in your credit score.
However, it is not necessary to actively seek out as many different forms of credit as possible. Instead, use various forms of credit as necessary and make timely payments. Your credit score will recover over time if you utilize credit responsibly.
Your Credit Use Could Have Increased.
Utilization is an extra aspect that impacts your credit score; it is the quantity of available credit that you actually use. For instance, if the only account you have is a credit card with a $1,000 limit and a $200 balance, you are utilizing 20% of your available credit.
Lenders like to see you utilizing 30 percent or less of your available credit since this demonstrates your ability to manage your finances without relying excessively on credit.
If you pay off a credit card balance and end the account, your total available credit lowers. Consequently, your overall use may increase, resulting in a decrease in your credit score.
The general guideline is to keep older accounts active, even if you don’t use them frequently unless they have an annual charge or another compelling reason to shut them.
Other Reasons Why Your Credit Score May Decline After Paying Off Debt.
Although the most prevalent causes of a credit score reduction after paying off debt have been outlined, there are more possibilities.
You may still make sound financial decisions if you get why paying off debt temporarily lowers your credit score, and you can strive toward a higher credit score over time.
Consider the following if you see a difference in your credit score after paying off debt:
- You paid off an older account in collections: In rare instances, paying off an older account in collections might result in the collection agency modifying the date of the debt. Since the debt reappears on your credit record as a fresher account, it may have a greater influence on your score.
Insufficient time has passed since the debt was settled: The credit bureaus may not get notification of your debt payment for at least 30 days, so you should check your credit report to determine if the account has been reported as paid off.
- Your credit score decline is unrelated to debt repayment: Despite the possibility that your credit score would decrease after paying off debt, this may not be the explanation for the decline. There might be many additional causes for a change in your credit score, as credit ratings are a complex computation. You may have applied for a new line of credit, missed a payment on another account, or had false information on your credit report.
If you observe a decline in your credit score, you should obtain a copy of your credit report. After reviewing your credit reports from the three credit bureaus — TransUnion®, Experian®, and Equifax® — you will have a better understanding of the information they are reporting about you.
You should also pay particular attention to any bad items or false information displayed on your credit report, in addition to determining if your obligation is reflected as paid in full. Unfair negative things can have a detrimental impact on your credit score, and federal law permits you to challenge any false entries on your credit report.