While paying off your debts often helps improve your credit scores, this isn’t always the case. It’s possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt.
However, that doesn’t mean you should ignore what you owe. The benefits of paying your debts are far greater than the drop that you may see in your credit scores, and the negative impact is likely to be temporary.
Paying off debts can be a double-edged sword when it comes to your credit score. On one hand, staying current on payments and eliminating debt are financially responsible behaviors that should boost your creditworthiness. On the other hand, factors like your credit mix and the length of your credit history play key roles in determining your score as well. So in some cases, paying off a debt could actually cause your credit score to drop.
Confusing, right? Let’s break it down so you understand exactly how paying in full affects your credit
How Credit Scores Are Calculated
The first thing to understand is what goes into calculating your credit score. Although there are a few different scoring models, FICO and VantageScore are two of the most widely used.
These companies look at the information on your credit report to compute a three-digit score that summarizes your creditworthiness. The higher the number the lower lending risk you pose.
There are five major factors that influence your credit score:
- Payment history – Have you paid your bills on time? Late payments can seriously damage your score.
- Amounts owed – This revolves around your credit utilization ratio and how much you currently owe compared to your total available credit.
- Length of credit history – In general, the longer your credit accounts have been open, the better.
- New credit – Opening a lot of new accounts in a short period can indicate higher risk and hurt your score.
- Credit mix – Having different types of credit – like credit cards, installment loans, and a mortgage – can help your score.
So when you pay off a debt in full it doesn’t automatically mean your credit score will increase. The payoff could change some of these key influencing factors in ways that lower your score.
Why Scores Could Drop After Debt Payoff
There are a few reasons why paying a debt in full might cause your credit score to temporarily decrease:
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Credit utilization – Paying off a credit card or other revolving line of credit lowers your total balances owed, which reduces your credit utilization ratio. Great news, right? Not if it was your only account or your main source of available credit. Eliminating your largest line or closing your only credit source could actually increase your utilization across remaining accounts.
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Credit mix – If the paid-off loan was your sole installment loan – like an auto, student, or mortgage loan – then your credit mix narrows. Creditors like to see you can manage different types of credit responsibly.
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Length of history – Along the same lines, if the installment loan you paid off was also your oldest credit account, your length of credit history shortens when it’s closed. Age of accounts is an important factor.
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Scoring model – Depending on the credit scoring model used, paid collections or settlements may or may not impact your score. For example, VantageScore ignores all paid collections when calculating your score. But with a FICO model, any collections can ding your score for years, even if paid.
In many cases, these dings to your credit score are temporary and should rebound in a matter of months as you continue practicing good credit behaviors. However, credit mix and history can have longer-lasting impacts.
When Paying Debts Helps Your Credit Score
Paying off debt doesn’t always lower your credit score. Here are some cases when it could give your score a boost:
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Eliminating collections – If you had accounts in collections that you pay off, newer credit scoring models will ignore them. This can help raise scores calculated with versions like VantageScore 4.0 or FICO 10.
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Paying over time – Making consecutive on-time payments over months or years builds your credit through positive payment history. Paying off the balance ultimately shows lenders you can be trusted.
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Lowering balances – Paying down credit card or revolving debt decreases your credit utilization ratio, especially if you eliminate cards entirely. This can help improve your score.
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Removing missed payments – Catching up on late or missed payments through payoff stops the bleeding. No more damage will occur, and on-time history can start accruing.
Overall, it’s better to pay off debts in full if you can afford it, even if your credit score drops initially. You’ll save on interest, avoid collections, and strengthen your finances in the long run.
Tips for Raising Your Credit Score
If you see your credit score drop after paying a debt, don’t panic. Here are some tips for improving it going forward:
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Make all bill payments on time. Delinquencies severely hurt your score, so prompt payment is key.
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Keep balances low on credit cards and lines of credit. High utilization damages your score, so try to keep it under 30%.
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Hold onto installment loans if possible. Don’t close your oldest credit sources if you can avoid it.
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Limit new credit applications. Too many hard inquiries from applying for new credit makes lenders cautious.
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Wait for time to pass. The impact of changes to your history and utilization fade over a few months.
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Correct errors on your credit report. Mistakes could be tanking your score, so dispute any inaccuracies.
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Practice good money habits. Budgeting, saving, and being a responsible borrower will benefit your finances and creditworthiness.
The Takeaway
Will paying a debt in full increase your credit score? Not necessarily. In some cases, it might cause your score to temporarily drop due to shifts in your credit utilization, history length, or mix. But avoiding interest and getting out of debt is still smart financially.
Pay off debts you can, keep practicing good credit habits, and your score should rebound or continue improving over time. Payoff might cause a slight initial dip, but the long run benefits are well worth it.
When will my credit scores improve after paying off my debts?
Paying off debt is more likely to help your credit scores than to hurt them. You are likely to see your credit scores improve after paying off debt unless the debt you repaid meets the unique criteria listed above.
What elements affect my credit scores?
To better understand why you could see lower credit scores after paying off debt, consider the elements that go into calculating your scores.
Your credit scores are based on information from your credit reports, which are generated by each of the three nationwide consumer reporting agencies (CRAs). The nationwide CRAs — Equifax, TransUnion and Experian — receive information about your lines of credit such as personal loans, credit cards and auto and mortgage loans.
Your credit scores are then calculated based on a formula that determines your creditworthiness, or how likely you are to make your debt payments on time. Credit scores are one factor that lenders may consider when deciding whether to extend credit to you.
There are many formulas used to calculate credit scores. However, most consider the following factors:
- Payment history. Your payment history shows how you have repaid credit in the past. Certain behaviors, such as late or missed payments, can have a negative impact on your scores.
- Length of credit history. Your credit reports track the amount of time your credit accounts have been active. A longer credit history can have a positive effect on your scores.
- Newer lines of credit. Any recent credit accounts you have opened are also taken into consideration when calculating your credit scores.
- Credit mix. Your mix of credit accounts — including loans, credit cards and mortgages — is generally considered when calculating your scores, and a diverse credit portfolio can have a favorable impact.
- Credit utilization ratio. The amount of revolving credit you’re using divided by the total credit available to you is known as your credit utilization ratio and can also have an impact on your scores.
Paying Collections – Dave Ramsey Rant
FAQ
Will my credit score go up if I pay in full?
Paying off your credit card debt each month is one of the most consistent ways to help improve your credit scores.
How many points will my credit score increase if a collection is paid in full?
How Much Will Credit Score Increase After Paying off Collections? Your credit score may not increase at all when you pay off collections. However, if your debt is reported using a newer credit scoring model, your score may increase by however many points were impacted by the collections debt.
Will a paid-in full collection help my credit score?
… collections: VantageScore 3.0 and 4.0 do not penalize paid collections, so those scores will be positively affected if you pay a collections account in fullJan 7, 2025
Does paying your credit card in full improve credit score?
Most of the time, paying off your credit card in full is the best approach. Carrying a balance on your credit card does not help your credit score. Doing so can also result in extra fees and interest charges.