Paying off debt can be hard work, so it can be disheartening to see that your credit score actually dropped after you’ve repaid some debt. While it may seem counterintuitive, it can happen.
Credit scores are calculated using several factors, and paying off debt can drag down some variables. For example, if you close your oldest credit account after paying off the loan, the average age of your credit history will be lower — and your credit score may take a hit.
Fortunately, you can build your credit back up. Good credit habits will improve your score in the long run.
On this page
- When does paying off debt lower your credit score?
- Can your credit score improve after paying off debt?
- How can you improve your credit score?
- Frequently asked questions
When does paying off debt lower your credit score?
Creditors report your financial and payment information to the three major credit bureaus, which then use the data to estimate your creditworthiness in the form of a three-digit credit score. Your credit score helps lenders decide whether to approve future credit accounts and the interest rates you’ll have to pay. The five main factors that make up a credit score are:
- Payment history: 35%
- Amounts owed: 30%
- Credit history length: 15%
- Credit mix: 10%
- New credit: 10%
Some of those factors may not be negatively impacted by paying off debt. For example, making on-time payments only helps your payment history — it doesn’t hurt it. But there are some circ*mstances in which these factors take a small hit when you pay off debt.
Paying off debt can lower your credit score when:
- It changes your credit utilization ratio
- It lowers average credit account age
- You have fewer kinds of credit accounts
- There’s a lag in credit reporting
- The drop is unrelated to debt payoff
It changes your credit utilization ratio
Lenders like to see that you’re using some of your available credit, but not too much. Carrying some debt, as long as you’re making payments on time, may help your score in the long run. Your credit utilization ratio shows how much of your available credit you’re currently using. Keeping your utilization under 30% shows that you can manage your debt effectively.
Credit bureaus add up the amount of available credit across all your accounts. Imagine that you have two accounts: a credit card with a $10,000 limit and a personal line of credit with a $5,000 limit. Your total available credit is $15,000. If you carry a $4,000 credit card balance and then choose to close your line of credit, your credit utilization ratio increases from 27% to 40%. The jump in your credit utilization ratio is likely to hurt your score.
It lowers average credit account age
Lenders like to see a track record of responsible credit usage, and that includes the length of time you’ve been using credit. Generally, the longer your average credit account age, the better.
If you have an older credit card that you don’t use much, you may be considering closing the account. While you shouldn’t keep a credit line open simply to benefit your credit score, you should know that closing the card could cause your score to drop. Closing a long-standing card will lower the length of your credit history, which can cause your score to drop.
Imagine you have three credit cards, and they’ve been open for two, seven and nine years. The average age of your accounts is six years. If you were to close the oldest card, the age of your accounts would drop to four and a half years, and that drop could negatively impact your credit score.
You have fewer kinds of credit accounts
To achieve a high credit score, it can help to have a diverse mix of credit accounts: credit cards, mortgages, auto loans and student loans. Once you make the final payment on your car loan and the account closes, you may have a less diverse credit profile. While repaying a loan in full is cause for celebration, you can expect to see your score dip a bit.
There’s a lag in credit reporting
Creditors don’t always report credit events to the bureaus right away. In some cases, it can take 30 days for a payment to be reported to those agencies. If you pay off a debt, don’t expect your credit score to go up immediately — it can take some time.
The drop is unrelated to debt payoff
Since your entire credit history goes into calculating your credit score, unrelated events could hurt your credit score, even if you pay off debt on one account. For example, taking too many hard credit inquiries while applying for loans can drag down your score, so even if you’re paying off your debt, those applications can impact your score.
Can your credit score improve after paying off debt?
Your credit score may improve over time after paying off debt, though it can take some time. If your debt payments bring your credit utilization ratio back under 30%, for example, your score can improve.
If you’ve encountered some bumps in the road and have missed payments, had debt in collections or filed for bankruptcy, your credit score will take a while to recover. Negative credit events don’t stay on your credit report forever, but most remain for at least seven years. Once a negative event falls off your report, your score will go up.
How can you improve your credit score?
Even if you’re working on paying off debt, there are other ways to improve your credit score during that process. Keep in mind that consistency is key — building or repairing credit won’t happen overnight. Here are a few steps you can take to ensure your credit profile is strong:
Make timely payments. Your payment history is the most important part of your credit score, and missed payments can drag your score down significantly. When repaying a loan, be sure to make all of your payments on time. If you think you might be at risk of missing a payment, ask your creditor if it would be willing to adjust your payment schedule.
Keep your accounts open. Even if you’ve paid off your debt, keeping the account open can help boost your credit. Having a higher credit limit can help your credit utilization ratio, and having older accounts helps extend the average age of your credit.
Don’t open too many new accounts. Opening new credit accounts can sometimes be unavoidable (if you want to buy a house, you’ll likely need a mortgage). But remember that hard credit inquiries can knock your score down a few points, and taking out too many loans too quickly can also hurt your score.
Credit scores can go down for a variety of reasons. If you miss a payment, use too much of your available credit lines or have a debt go to collections, your score will take a hit. Some credit events have a small impact, like a hard credit inquiry, while others have an enormous effect, like filing for bankruptcy.
Yes, you can pay off debt without lowering your credit score. In many cases, as long as you keep accounts open and make regular payments, your score is unlikely to go down. Just make sure to avoid unrelated activities that may lower your score (like several hard credit checks, for example).
If you establish a good pattern of responsible credit use — making payments on time, opening new accounts sparingly and using different kinds of accounts — your credit score will eventually improve, even if it’s taken a temporary hit after you’ve paid off your debt.
