While paying off debt can help your finances in many ways, it might lead to an unfortunate -- but temporary -- drop in your credit score.
Many factors make up your credit score, so there are a few different reasons why paying off debt can leave you with a lower score in the short term. Here’s how your credit score is calculated, why paying off debt can lower your score and what you can do to get it back up.
What factors determine your credit score?
To understand why your credit score might have dropped after paying off debt, you must first understand the factors that make up your score. Here are the FICO score factors:
- Payment history (35%). This factor has the largest impact on your credit score. It looks at whether you pay on time and if you pay at least the minimum amount.
- Credit utilization (30%). Also called “accounts owed,” this factor analyzes how much credit you’re using versus how much you have access to.
- Length of credit history (15%). This factor considers the average age of your credit accounts.
- New credit (10%). This factor considers how many recent credit accounts you opened. Initiating too many in a short period can lower your score.
- Credit mix (10%). This last factor weighs the different types of credit you have.
5 ways paying off debt can lower your credit score
Although lowering the amount of credit you owe is generally a smart step for your financial health, your credit score could temporarily decrease once your debt is paid off. Here are a few of the most common reasons why.
1. Your credit utilization ratio went up
Your credit utilization ratio is the percentage of credit you use versus the total amount available. For example, if you carry $3,000 in total credit card debt across $10,000 total available credit, your credit utilization ratio is 30% ($3,000 divided by $10,000). Most experts recommend staying at 30% or below.
Credit utilization, or amounts owed, make up 30% of your credit score. VantageScore considers only revolving lines of credit -- like credit cards -- in its credit utilization ratio, while FICO considers all debts owed, including installment loans, like personal loans, in its calculation.
Here’s how paying off a credit card could affect your credit utilization ratio. Imagine you have two credit cards, each with $5,000 credit limits. One card has a $4,000 balance, and the other has a $1,000 balance. In this case, your credit utilization rate is 50% ($5,000 divided by $10,000).
If you pay off the $1,000 debt and close the card, your credit card debt to credit availability ratio would jump to 80% ($4,000 divided by $5,000). So, even though you paid down some of your debt, this shift in credit utilization could cause your score to drop.
One way to avoid this would be to pay off the $1,000 debt and keep the account open. That would leave you with a $0 balance and a $5,000 limit, lowering your credit utilization ratio to 40% across both accounts. Your credit score could potentially improve.
2. Your average credit account age decreased
Since the average length of your credit history makes up 15% of your credit score, closing one of your oldest accounts can bring down this average and hurt your score.
This is another reason why most experts recommend keeping accounts open when you can, even if you’re not using them and they have a $0 balance.
You might not have control over this when paying off a debt like a student loan, but you can control it for other accounts like credit cards. Keeping your oldest credit card open, for example, as long as it has no annual fee, can help keep your average credit account age up.
However, there’s no need to panic if you do need to close an account. So long as it’s in good standing, it’ll still affect your credit report for 10 years, according to Experian.
3. You now have fewer types of credit accounts
FICO and VantageScore consider how many types of credit you have and provide more favorable scores to people with a good mix of credit accounts.
While you don’t need one of every type of account, you’ll score better if you have a mix of revolving accounts, like credit cards, retail cards or a HELOC, and installment accounts, like a student loan, auto loan or mortgage.
If you close an account that changes your credit mix, it could hurt your score. For example, if you only have credit cards and one personal loan and pay off your personal loan, you’re down to a single type of credit.
4. There’s a lag in credit reporting
Credit card issuers and lenders typically report to the credit bureaus only once each billing cycle.
As a result, the major credit bureaus -- Experian, Equifax and TransUnion -- only update credit reports once every 30 to 45 days.
So if you recently paid off debt, it may not reflect on your credit score by the time you check.
5. There’s a different issue affecting your credit score
Since a range of factors can affect credit over time, the dip in your score may be unrelated to your recent debt payoff.
You should check your credit score to see if anything else has changed. Maybe you accidentally made a late payment on a different account, or a new credit inquiry caused a slight drop in your score. An error on your credit reports may also harm your score. It’s important to regularly check your credit reports for inaccuracies. You can access your credit reports with all three credit bureaus for free weekly at AnnualCreditReport.com.
How long will it take for your credit score to recover?
Most credit score drops based on debt payoff alone are only temporary, and it shouldn’t take more than a few months for your credit to rebound, according to Experian. In the meantime, the best thing you can do is monitor your credit report and ensure you pay all of your bills on time.
How to increase your credit score after paying off debt
Here are a few easy ways to help improve your credit score:
- Make on-time payments. Because payment history is the biggest contributor to good credit scores, make sure your bills are all paid early or on time to help build up your credit score.
- Pay down your balances. Credit usage is another big part of your score, so paying off as much of your credit card balances as you can will increase your available credit and lower your credit utilization.
- Get credit for regular bills and subscriptions you pay for. Use a free app like Experian Boost to get credit for utility bills you pay, subscription services you use, and even your rent payment.
- Keep old accounts open. Finally, remember to keep revolving accounts open and working in your favor. There’s no reason to close old accounts if you don’t have to.
FAQs
This could be due to changes in your credit utilization ratio or credit mix. It’s also possible that the drop in your credit score was unrelated to the debt payoff.
If you paid off a credit card and closed the account, in most cases, your credit score likely dropped because your credit utilization ratio increased. A credit card closed in good standing should stay on your credit report for 10 years, so it probably wasn’t the immediate cause of the drop.
After you pay off debt, your credit score may increase, decrease temporarily or stay the same. It depends on your credit profile, the type of debt you’re paying off and whether you close the account.
The editorial content on this page is based solely on objective, independent assessments by our writers and is not influenced by advertising or partnerships. It has not been provided or commissioned by any third party. However, we may receive compensation when you click on links to products or services offered by our partners.
