Bankruptcy HQ Explained Why Did Credit Score Go Down After You Paid Off All of Your Debt
Since paying off debt is such a tremendous accomplishment, you may be dismayed to learn that doing so can result in a reduction in your credit score. When you see the points deducted from your credit score, it can feel like a loss. However, if you understand why this happened, you can devise a strategy to bring your score back up. Gaining an understanding of the elements that influence your credit score and the steps you can take to maintain a healthy score even after paying off your debt is essential.
When I finally paid off my loan, why did my credit score take a hit?
Your credit score is determined by applying a certain formula to your credit report. The higher your score, the more likely it is that you will be able to make on-time payments for a loan. The calculation of a credit score is based on a number of elements, and although paying off debt has a favorable impact on some of these factors, it does not have this effect on all of them. If you pay off your debts, this could have a negative impact on your credit score depending on how it affects your credit mix, credit use, and average account age. The following are some circumstances that could have a negative impact on your credit score:
- You paid off your one and only installment loan or revolving debt: congratulations! Creditors enjoy it when borrowers can demonstrate that they are able to handle multiple sorts of debt. If paying off a specific loan makes your credit report contain fewer different types of debt, this can have a negative impact on your score. Your credit mix will suffer, for instance, if you pay off an auto loan and are then left with solely credit cards as sources of borrowing.
- You have increased your overall credit use, which includes the following: A higher credit score is the result of not using all of your available credit to its maximum limit; in other words, maintaining a low overall use of your available credit (not maxing out all of your credit cards or lines of credit). But if you pay off an existing revolving line of credit or credit card in full and then close the account or let the account go inactive (which typically results in the account being closed), the total amount of credit that is available to you will decrease, which may result in an increase in your remaining utilization rate.
- You’ve managed to bring the average age of your accounts down: The longer your accounts have been active while remaining in good standing, the better off you will be. Even if you don’t use the account, having one that’s been there for 20 years on your credit report is a positive indicator; canceling that account and being left with accounts that are no older than five years brings the average age of your accounts down by a significant amount.
Advice on how to improve your credit score after paying off your debts
While paying off your credit card debt is certainly vital, making your payments on time and keeping track of your utilization rate is of far more significance. Borrowers often neglect these criteria because they believe that paying off their debt as quickly as possible is the most important aspect of determining their credit score. However, there are a few alternative approaches that should be taken into consideration:
- Paying off your obligations should be done in a methodical and deliberate manner. Most of the time, the interest rates on personal loans and credit cards are far higher than those on mortgages, auto loans, and school loans. If you take care of those debts first, you’ll not only be able to maintain a better handle on how much of your available credit you’re using, but you’ll also reduce the amount of interest you owe You may also use a debit paydown calculator to assist you in determining the order in which it makes the most sense to handle your debts.
- Check how much of your credit is being used. Examine the percentage of your available credit that you are utilizing if you have just paid off your debts but have seen a drop in your credit score as a result. If it’s more than 30 percent, you might want to consider lowering the amount that you charge each month. If it is not a possibility for you, you could talk to the issuer of your credit card about increasing your credit limit. Your credit score is likely to improve as a result of both of these factors.
- Start using yet another credit card. When you open new accounts, your credit score may momentarily drop due to the hard credit checks that are performed. However, opening a new credit card may boost your total available credit and allow you to spread your charging across numerous cards.