Paying off that large balance you carried for months on your credit card or making one last deposit toward your years of student loans is an unbeatable feeling. But more than just bringing you peace of mind, paying off your revolving and installment debts brings you closer to financial freedom.
Revolving credit (credit cards) is an extension of credit with an assigned spending limit but no end time to the loan, while installment credit(loans) offers borrowers a fixed amount of money over a specified period of time. No matter what kind of debt you owe, you typically have to pay interest on the outstanding balances. The sooner you can pay these debts off, the less money coming out of your pocket.
That said, acommon misconceptionis that paying off your debt always and instantly increases your credit score.It's true that getting rid of your revolving debt, like credit card balances, helps your score by bringing down your credit utilization rate. Yet, closing certain lines of credit can actually temporarily ding your credit score. Paying off your installment loans, which also includes things like car loans and mortgages, can sometimes have the opposite effect.
"It can be frustrating to see a drop in your credit score when you make a smart financial decision," says Amy Thomann, head of consumer credit education at TransUnion, one of thethree main credit bureaus.But before you get discouraged, know why it happens and how much it matters in the long run.
According to Experian,another credit bureau, there are a few reasons why your score may drop when you pay off an installment loan.
- You paid off your only installment account:Lenders like to see that you can manage a variety of different types of debts. Considering your mix of credit makes up 10% of your FICO credit score, paying off the only line of installment credit can cost you some points.
- You paid off your lowest balance account: The outstanding balances across all of your open credit accounts, or your amounts owed, makes up 30% of your credit score. If the installment loan that you paid off had the lowest balance, thus bringing down the average amount owed and leaving your only remaining active accounts with high balances, your credit score may drop.
- Something else happened: Though you paid off an installment loan and immediately saw your credit score decrease, it could just be a mere coincidence and something else caused your credit score to drop. Remember that a bunch of factors impact your score, such as applying for a loan or new credit card or racking up a high credit card balance in the meantime.
If you do experience a dip in your credit score when paying off an installment loan, know that it is likely small and only temporary.
Why you should still aim to pay off your debts anyway
Just because paying off an installment loan could ding your credit score, don't keep it open just for the sake of maintaining a high score.
You wouldn't want to pay unnecessary interest over time just to save a few points, and your 3-digit score can bounce back. The average credit score recovery time after closing an account (for those with poor to fair credit) is three months, according to Bankrate. Making a series of monthly on-time bill payments is the fastest route to improving your score. (Payment history is the most important factor.)
"Remember: your credit score is just one piece of your overall financial health,"Thomann says, emphasizing the importance of reducing interest and overall debt. "That you're making the effort to actively engage and take control of your credit health makes it more likely you'll reach your financial goals over time."
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FAQs
Paying off your only line of installment credit reduces your credit mix and may ultimately decrease your credit scores. Similarly, if you pay off a credit card debt and close the account entirely, your scores could drop.
Does paying off debt hurt your credit score? ›
It might reduce the types, or 'mix,' of credit you have
But now you have one less account, and if all your remaining open accounts are credit cards, that hurts your credit mix. You may see a score dip — even though you did exactly what you agreed to do by paying off the loan.
How many points does your credit score go up when you pay off a debt? ›
If you're close to maxing out your credit cards, your credit score could jump 10 points or more when you pay off credit card balances completely. If you haven't used most of your available credit, you might only gain a few points when you pay off credit card debt. Yes, even if you pay off the cards entirely.
Why did my credit score drop when I paid off a loan? ›
You now have fewer types of credit accounts
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.
Why did my credit score drop 100 points after paying off a car? ›
Paying off something like your car loan can actually cause your credit score to fall because it means having one less credit account in your name. Having a mix of credit makes up 10% of your FICO credit score because it's important to show that you can manage different types of debt.
Why did my credit score drop 40 points after paying off debt? ›
If you take out a loan to consolidate debt, you could see a temporary drop because of the hard inquiry for the new loan. Your credit score can take 30 to 60 days to improve after paying off revolving debt. Your score could also drop because of changes to your credit mix and the age of accounts you leave open.
Is it smart to pay off debt? ›
Key takeaways. If the interest rate on your debt is 6% or greater, you should generally pay down debt before investing additional dollars toward retirement. This guideline assumes that you've already put away some emergency savings, you've fully captured any employer match, and you've paid off any credit card debt.
Why did my credit score drop 70 points after paying off debt? ›
It's possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt. Paying off debt might lower your credit scores if removing the debt affects certain factors like your credit mix, the length of your credit history or your credit utilization ratio.
How long does it take to rebuild credit after debt settlement? ›
There is a high probability that you will be affected for a couple of months or even years after settling your debts. However, a debt settlement does not mean that your life needs to stop. You can begin rebuilding your credit score little by little. Your credit score will usually take between 6-24 months to improve.
How to get 800 credit score? ›
Making on-time payments to creditors, keeping your credit utilization low, having a long credit history, maintaining a good mix of credit types, and occasionally applying for new credit lines are the factors that can get you into the 800 credit score club.
How to Raise your Credit Score by 200 Points in 30 Days?
- Be a Responsible Payer. ...
- Limit your Loan and Credit Card Applications. ...
- Lower your Credit Utilisation Rate. ...
- Raise Dispute for Inaccuracies in your Credit Report. ...
- Do not Close Old Accounts.
Credit scores can drop due to a variety of reasons, including late or missed payments, changes to your credit utilization rate, a change in your credit mix, closing older accounts (which may shorten your length of credit history overall), or applying for new credit accounts.
Should I pay off my credit card in full or leave a small balance? ›
It's a good idea to pay off your credit card balance in full whenever you're able. Carrying a monthly credit card balance can cost you in interest and increase your credit utilization rate, which is one factor used to calculate your credit scores.
Is 700 a good credit score? ›
For a score with a range between 300 and 850, a credit score of 700 or above is generally considered good. A score of 800 or above on the same range is considered to be excellent. Most consumers have credit scores that fall between 600 and 750.
What is the average credit score? ›
The average FICO credit score in the US is 717, according to the latest FICO data. The average VantageScore is 701 as of January 2024. Credit scores, which are like a grade for your borrowing history, fall in the range of 300 to 850. The higher your score, the better.
Should I pay off closed accounts on my credit report? ›
While closing an account may seem like a good idea, it could negatively affect your credit score. You can limit the damage of a closed account by paying off the balance. This can help even if you have to do so over time.
How long does it take to rebuild credit after paying off debt? ›
It can take weeks or even days for you to notice a change in your credit score. If you have recently paid off a debt, wait for at least 30 to 45 days to see your credit score go up.
How can I pay off my debt fast without hurting my credit score? ›
Tips for Consolidating Credit Card Debt Without Hurting Credit
- Keep old credit cards open. (But try not to use them.)
- Pay off balance transfers quickly.
- Avoid taking on additional debt.
- Make on-time payments.
For some credit scoring models, paying off collection accounts may improve credit scores. FICO® Score 9, FICO Score 10, VantageScore® 3.0 and VantageScore 4.0 credit scoring models penalize unpaid collection accounts. Paying off collection accounts may help improve these scores.
What are the disadvantages of paying off debt? ›
If you send extra money to your lender each month to pay down your debt, you may develop a cash flow problem in the short term because money that would otherwise have been available to you will now be going to your lender. That may require you to readjust your budget and reduce some of your other spending.
