If you've recently paid off a credit card or loan, you might have been expecting your credit score to rise. After all, paying off debt should be a positive step toward better financial health, right? So, it can be confusing—and frustrating—if your credit score goes down. But don't worry! There are several reasons why this can happen, and understanding them can help you take control of your credit score going forward.
1. Credit Utilization Ratio
One of the biggest factors that impact your credit score is your credit utilization ratio—the amount of credit you're using compared to your total available credit. It accounts for around 30% of your credit score.
When you pay off a credit card, you lower your overall debt, but you also might inadvertently increase your utilization rate. Here's how:
Let’s say you have two credit cards, each with a $1,000 limit. You have a balance of $500 on one and $0 on the other. Your utilization rate is 25% ($500/$2,000).
After paying off the $500 balance, your total utilization rate may now appear lower on the card you paid off, but if you didn’t reduce the balance on the other card, your overall available credit could appear higher compared to your usage—potentially lowering your score if your utilization rate is still high.
In simple terms, paying off one card might leave you with a lower total balance, but if you don’t adjust your spending habits across all your cards, it can still affect your credit utilization ratio negatively.
2. Changes in Credit Mix
Your credit score also takes into account the variety of credit accounts you have, such as credit cards, mortgages, and car loans. This is known as your credit mix and contributes around 10% of your score.
If you pay off a revolving credit account (like a credit card), it could affect your credit mix. While paying off a credit card is a good thing for your debt, it may reduce the number of credit accounts you have open, which could lower the diversity in your credit mix. A lower variety of open credit accounts may hurt your credit score slightly, especially if you’re losing a key piece of your credit profile, such as a credit card with a long history.
3. Closing Accounts Can Impact Your Credit History
If you close an account after paying it off, you could lose the credit history attached to it, which is another factor that impacts your credit score. The longer you have a credit account open, the better it is for your credit score, as it shows you have a track record of managing credit responsibly.
If you pay off your credit card and then decide to close the account, you might lose that positive history, which could lower your score. The longer you keep your account open (and in good standing), the better for your credit score in the long run.
4. Hard Inquiries from New Credit Applications
If you've recently paid off your credit card or loan and then applied for new credit, this could result in a hard inquiry on your credit report. Hard inquiries temporarily lower your credit score, and even if the new credit is approved, the inquiry can impact your score for a few months.
It's best to avoid applying for new credit immediately after paying off a debt if you want to keep your score in the best shape possible.
5. Credit Score Model Variations
Different credit score models might also treat changes to your credit report in slightly different ways. For example, if you're looking at your FICO score, paying off a credit card might affect it in one way, while your VantageScore might reflect the same action differently.
Sometimes, small fluctuations in your score can simply be due to how the score model is assessing your data, so don’t panic if you see a dip. In some cases, the dip is only temporary, and your score may rise in the following months.
6. Your Credit Score Is a Reflection of Ongoing Behavior
Lastly, it's important to remember that your credit score isn't static. It changes based on your ongoing financial behavior. Paying off a debt is a great step, but continuing to make timely payments, keep your credit utilization low, and avoid accumulating new debt are key factors in maintaining and improving your score over time.
What Should You Do If Your Credit Score Goes Down After Paying Off Debt?
Don’t Close Accounts: Keep your accounts open, even after paying them off, to maintain your credit history.
Monitor Your Credit Utilization: Keep an eye on your credit usage across all your accounts and aim to keep it below 30%.
Check Your Credit Reports: Sometimes, errors on your credit report could be the cause of a dip. Regularly checking your reports ensures there are no mistakes or fraudulent activities.
Avoid New Credit Applications: If possible, avoid applying for new credit in the short term after paying off debt, as hard inquiries can hurt your score.
While it can feel discouraging to see your credit score dip after paying off a debt, it's important to remember that the situation is usually temporary. Your credit score is dynamic, and with the right strategies, it will improve over time. Keep monitoring your credit, paying bills on time, and staying mindful of your credit utilization to build a strong, healthy credit profile.
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