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Explained: Why Your Credit Score Dropped After Paying Off Debt

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Jessica Merritt
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Jessica Merritt

Editor & Content Contributor

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A long-time points and miles student, Jessica is the former Personal Finance Managing Editor at U.S. News and World Report and is passionate about helping consumers fund their travels for as little ca...
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Chris Dong

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Chris is a freelance writer and editor with a focus on timely travel trends, points and miles, hot new hotels, and all things that go (he’s a proud aviation geek and transit nerd). Formerly full time ...
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Paying off debt should boost your credit scores, but you may see your credit score drop after paying off an account. You might be discouraged, but the truth is it’s usually not paying off debt that lowers your credit score, but rather closing an account after you pay off debt.

For example, paying off a car loan or paying off and closing an old credit card account you’ve been carrying debt should be exciting financial achievements, so it might feel insulting to see your credit score drop after closing out those accounts.

Let’s explore why paying off debt sometimes translates into a lower credit score — and what you can do to preserve your credit score while becoming debt-free.

Why Credit Scores Sometimes Lower After Paying Off Debt

It’s frustrating to see your credit score lower after you pay off debt, but it helps to understand why it happens. Knowing how to avoid damaging your credit score when you pay off debt is also good. Usually, the problem lies in closing accounts.

How Paying Off Debt Affects Credit Scores

When you pay off a loan or credit card and close the account, it affects your total available credit, credit mix, and length of your credit history. Changes to all of these factors can lower your credit score. It usually just takes a billing cycle for your credit score to update. That’s when your creditors report updates to your account to the credit bureaus.

Lowering Your Available Credit

The most important factor is your available credit, which is lowered when you close a line of credit. For example, when you close a credit card, you’ll lose all the available credit on the account. That can result in a higher credit utilization ratio, which can lower your credit score.

Eliminating Credit Diversity

Closing an account can also affect your credit mix. For example, if your credit score dropped after paying off a car, it’s probably because your credit mix is less diverse without the long-term installment loan. 

Shortening Your Credit History

The length of your credit history matters, too. Let’s say you paid off an old credit card and decided you won’t use it anymore, so you close the account. Your credit score may drop because closing one of your oldest accounts negatively impacts the length of your credit history.

Still, credit score drops after paying off debt aren’t always the case. If you pay off your car loan but still have a mortgage, your credit mix should be fine because the mortgage is a long-term installment loan. Or if you pay off your old credit card but keep the account open, you’ve still got that credit line to boost your available credit and support healthy credit utilization.

Factors That Affect Your Credit Score

Your credit score affects your financial life and ability to access the best credit products. A good credit score can make borrowing money easier and less costly, while a bad credit score can make it tougher and more expensive to get a loan or credit card. 

While credit scores may seem somewhat mysterious, there are clear factors that influence how high or low your credit score is.

FICO and VantageScore, the 2 major credit scoring companies, use information collected from the 3 major credit bureaus (Equifax, Experian, and TransUnion) to calculate your credit score using proprietary algorithms based on credit score factors.

Let’s understand more about what makes up your credit score and how each factor is affected when you pay off debt.

The factors that make up credit scores are:

  • Payment history
  • Amounts owed, including balances, credit utilization, and available credit
  • Depth of credit or length of credit history
  • Credit mix
  • New credit or recent credit
FICO Score
It pays to understand what makes up your credit score. Image Credit: Experian

Payment History

Payment history indicates whether you’ve paid your bills on time. It makes up 35% of your FICO credit score and 41% on VantageScore, so it’s the most important factor for your credit. Paying off debt is a good move for your payment history, as you’ve made payments and satisfied your debt.

Amounts Owed

Your credit card balances affect your amounts owed, which affects your credit utilization. The higher your balances are, especially relative to your available credit, the lower your credit score will be. 

Higher credit utilization decreases your credit score because you’re using more of your available credit, and that’s a signal of risk to lenders. As a rule of thumb, you should use 30% or less of your available credit and do your best to avoid carrying balances month to month. 

You can calculate your credit utilization ratio by dividing your credit card balances by your total credit limit and multiplying by 100 to get the percentage. For example, if you have $3,000 in credit card debt and total credit limits of $10,000, you’d divide $3,000 by $10,000 to get 0.3, then multiply it by 100 to get a 30% credit utilization ratio.

When you pay off debt, you can improve your amounts owed factor, which is the second-most important factor for your FICO credit score and also plays prominently into your VantageScore.

Amounts owed count for 30% of your FICO credit score. On your VantageScore, balances affect your credit utilization factor (which makes up 25% of your score), your balances factor (which makes up 6% of your score), and your available credit factor (which is 2% of your score).

Depth of Credit

The length of your credit history isn’t as important as your payment history and amounts owed, but it is still a credit score factor and is easily affected by paying off debt. Lenders like to see a long track record of responsible credit use, so having long-term credit accounts can boost your credit score. 

You can shorten your credit history when you pay off a loan or credit card and close the account. That can drag down the average age of your accounts. And it’s especially harmful if you’re closing your oldest account, as you could chop years off your credit history length. 

Depth of credit, or the length of your credit history, counts for 15% of your FICO score and 20% of your VantageScore.

Credit Mix

Credit mix is another credit score factor that might be considered minor but is easily affected by paying off debt. Your credit mix is the diversity of credit account types you have. For example, you might have credit cards and installment loans such as student loans or a mortgage.

When you close an account after you pay it off, you might eliminate that type of credit from your credit history going forward. If you closed a student loan account and have no other installment loans on your credit report, your credit score might drop because your credit mix is less diverse.

Credit mix makes up 10% of your FICO credit score and is part of the depth of credit factor that makes up 20% of your VantageScore.

New Credit

Opening new accounts can indicate an increased reliance on credit and makes you a more risky borrower. This is a small credit score factor and is generally unaffected by paying off debt unless you’re closing old accounts and opening new ones.

New credit accounts for 10% of your FICO credit score, and recent credit is worth 11% on your VantageScore.

Hot Tip:

Learn more about every nuance and detail of your credit score in our comprehensive credit score guide.

How To Preserve Your Credit Score When Paying Off Debt

You’ve made debt payments for years, and you’re just about ready to pay off an account — congratulations! If you’re worried it will affect your credit when you finally pay off the debt, keep these tips in mind:

  • Keep Old Accounts Open: While a loan account will close when you pay it off, you can keep credit card accounts open. Just freeze your card and log in monthly to check for fraudulent activity. If there’s an annual fee, ask to downgrade your card to one with no annual fee. Also, make and pay off small charges now and then on the card to keep the account active and avoid involuntary closure.
  • Maintain a Good Credit Mix: If you’re about to pay off your only installment loan or credit card and close the account, you might see a drop in your credit score as your credit becomes less diverse. Keep your credit card account open, and consider whether getting another installment loan is worth it. Generally, it doesn’t make sense to open a loan account just to boost your credit, but it might help if you can get 0% financing for a purchase you need to make and can pay off without interest.
  • Make Payments on Time: Don’t neglect other accounts as you pay off debt. Make sure you’re making all of your payments on time to maintain a positive payment history.
  • Keep Your Credit Utilization Low: Paying off debt is great for improving your credit utilization ratio, but look at your accounts to see whether you carry high balances relative to your credit limit. Generally, it’s best to use 30% or less of your credit limit and avoid carrying balances month to month.
  • Avoid Opening Too Many Accounts: Opening new accounts and using them responsibly can boost your credit, offering more opportunities to build a positive payment history and expanding your available credit. But rapidly opening a series of new accounts can set off red flags for your credit.
  • Focus on Long-Term Credit Moves: Your credit score might take a hit after closing a paid-off account, but you can work on having great credit by consistently making on-time payments and keeping your credit utilization low.
Hot Tip:

Consolidating credit card debt? See our guide to find out how to consolidate credit card debt without hurting your credit.

Paying Off Debt Is Worth It

Man paying bill on cell phone with credit card
Paying off debt can give you more financial freedom, even if your credit score takes a hit. Image Credit: wayhomestudio via freepik

Don’t let the potential of a lower credit score keep you from paying off debt. Your credit score matters, but you don’t need to obsess over fluctuations in your score. 

Ultimately, a good credit score will get you the best credit card and loan products — usually with the lowest interest rates. And any credit score over 800 is basically perfect. Getting to the highest possible credit score of 850 is unnecessary because you don’t have to get that far to access the benefits of excellent credit.

There’s no prize for a perfect credit score other than the ability to take on more debt.

You might be hesitant to pay off debt if your credit score suffers, but it doesn’t make sense to keep paying interest now out of fear that your credit score may drop. Even if your credit score takes a hit, it’s worth it to pay off debt so you’re not trapped in a cycle of paying interest every month. 

Final Thoughts

You might feel discouraged to see your credit score lower after you pay off debt, but paying off debt is ultimately a positive move. Closing accounts, especially some of your oldest credit cards, can negatively affect your length of credit and credit utilization, so it’s best to keep accounts open if you can, even after you’ve paid the balance.

As long as you make on-time payments, keep your credit utilization low, and avoid opening too many new accounts, you should see your credit score stabilize and improve over time.

Frequently Asked Questions

Should I pay off closed accounts on my credit report?

Paying off closed collection accounts can have a positive impact on your credit score. While the collection account will remain on your credit score, a paid status is better than unpaid or settled.

If I pay off all my debt will my credit score go up?

Paying off debt can improve your payment history and lower your credit utilization, both of which can improve your credit score. But if you close accounts after you pay off debt, your credit score may lower as the closed accounts affect your available credit and length of credit history.

What are the reasons for a sudden drop in my credit score?

A sudden drop in your credit score might be caused by missing a payment, dramatically increasing credit balances, or closing an old account that shortens the length of your credit history.

What is considered a big drop in a credit score?

A drop of 20 points or more might be considered large and could be enough to drop you from 1 credit bracket to the next, such as a drop from good credit to fair credit.

Why is my credit score going down when I pay on time?

On-time payments are a major factor for your credit score but not the only factor you should be concerned about. If you’re paying on time but using too much available credit, you could see your credit score drop because your credit utilization ratio is high.

Jessica Merritt's image

About Jessica Merritt

A long-time points and miles student, Jessica is the former Personal Finance Managing Editor at U.S. News and World Report and is passionate about helping consumers fund their travels for as little cash as possible.

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