4 reasons your credit score drops after paying off debts

When you pay off your debts, it seems natural that your credit score will rise. After all, a credit score should show your ability to manage debt responsibly.

But sometimes the opposite happens.When you pay off the debt, you may actually see your Credit score Decline in the short term. This is why your credit score may temporarily drop within a few months after you pay off your debt-and why you shouldn’t worry too much.

4 reasons your credit score drops after paying off debts

The credit score is a mysterious three-digit number that is generated by an algorithm based on your information Credit Report. Your score can predict how likely you are to repay debt. But sometimes the credit scoring math is not logical. Here are four reasons why your credit score may drop after you pay off your debt.

1. You have reduced your overall credit limit

Paying off credit cards before other debts is almost always a smart move. A credit card is usually your debt type with the highest interest.

Paying them off will reduce your Credit utilization, This is the percentage of outstanding credit you used. It determines 30% of your FICO score. However, if you close your old credit card after paying off, it will increase your credit utilization, so your score may drop. (Repaying a loan or mortgage will not reduce your credit utilization.)

Therefore, unless the card charges a high fee, you will want to keep it open.

2. You lowered your credit age

The scoring model wants to see that you can handle the long-term relationship with credit.Your Average credit age Account for 15% of your credit score. If you pay off the loan or close the credit card and it is one of your old accounts, your credit age will drop, which may lower your score.

This of course does not mean that you should avoid paying off the loan just to keep the account open. However, if you are ready to pay off the loan, be prepared for a temporary drop in your score.

3. Your credit portfolio has changed

The combination of credit cards and installment loans (such as car loans or mortgages) has received positive reviews in the area of ​​credit scoring.Your Credit portfolio In FICO’s model, 10% of your score is determined, which means that its impact is relatively small.

However, if you pay off your student loan or car loan and leave only your credit card as an outstanding account, your credit portfolio will change. If your credit score drops by a few points, then the change in your credit portfolio may be the culprit.

4. Another factor is blame

Fluctuations in credit scores are completely normal. If your score only goes up or down by a few points, it is difficult to attribute this change to any one factor. However, if you see a significant drop, please check your credit report: Annual Credit Report.com To make sure everything is accurate. About one-fifth of the reports contained inaccurate information.

Some other possible explanations for the drop in scores after paying off debts:

• You delayed payment on another account. Your Payment history It is the most important credit factor, accounting for 35% of your score. Late payments will remain on your credit report for seven years, but the damage will have the greatest impact on the scores of the first two years.

• You have increased the balance of another account. If you pay off one credit or loan balance, but increase the balance of another, your credit utilization rate may increase, which will cause your score to drop.

• You opened a new credit. Opening a new credit usually lowers your credit score in the short term because you lower the average credit age and you get Hard inquiry On your credit report.

Should your credit score drop, should you care?

Any drop in your score may be temporary. Most people will see their scores recover within a few months.

Although it is frustrating to see your score drop, remember that lenders consider many factors when determining whether to approve you for credit and how much interest you will pay.An important consideration is your Debt-to-income ratio, It may be lower after you pay off the debt. However, if you plan to make a large purchase, it’s worth waiting for a few months until your score picks up.

Bottom line: Never default on debt just because you are worried about the impact on your credit score. Regardless of your credit score, repaying debt is a good thing.

Robin Hartill is Penny Hoarder’s certified financial planner and senior author. She wrote a column of personal financial advice for Dear Penny.Send your tough money questions to [email protected]