Does Paying Off Debt in Full Hurt Your Credit Score?

Paying off debt is usually seen as a positive financial move. However, some people worry that paying off an installment loan like a mortgage or auto loan early might hurt their credit score. So does paying off debt in full negatively impact your credit?

The short answer is no – paying off debt in full does not hurt your credit score. In fact, it can actually help raise your credit score in many cases Here’s a more in-depth look at how paying off debt affects your credit

How Paying Off Debt Impacts Your Credit Score

To understand how paying off debt impacts your credit score it helps to first understand what makes up your credit score. The three major credit bureaus (Experian, Equifax and TransUnion) use proprietary scoring models to calculate your credit score. But the most commonly used model is the FICO score, which weighs the following factors

• Payment history (35%) – Your track record of on-time payments on all credit accounts.
• Amounts owed (30%) – Also called credit utilization ratio. Measures how much of your available credit you are using.
• Length of credit history (15%) – How long you’ve had credit accounts opened.
• New credit (10%) – Number of new credit accounts recently opened.
• Credit mix (10%) – Mix of different types of credit accounts – installment loans, credit cards, etc.

Now let’s look at how paying off debt can impact some of these key factors

Payment History

When you pay off an installment loan early, your payment history remains positive. Since payment history makes up over a third of your credit score calculation, this is very helpful for your score.

Even if the loan was delinquent or late before you paid it off, the act of paying it off itself does not negatively impact your payment history. Any late payments that occurred remain on your credit report for up to 7 years, but are not made worse by paying off the debt.

Credit Utilization

Paying off installment debt – especially large loans like a mortgage – can dramatically reduce your overall credit utilization. This ratio makes up 30% of your credit score, so lowering it by eliminating debt can give your score a nice boost.

For example, if you have a $100,000 available credit limit across all cards and loans, and $85,000 of that is being used, your utilization is 85% – considered very high. But if you pay off a $50,000 mortgage, your utilization instantly drops to 35% just by eliminating that debt.

Credit History

One myth about paying off loans early is that it can shorten your length of credit history. However, this is not true – your credit report will continue to show those accounts for 10 years after they are closed. Having a strong history of long-open and paid-off accounts actually strengthens your score.

The one exception is if you pay off an account within the first year of opening it. Since new accounts aren’t fully factored into your score until they are 12 months old, paying off very new debt can remove it before it helps your history length.

New Credit

Paying off debt does not count as applying for new credit, so it does not impact the new credit portion of your score at all. This is only affected when you open new accounts.

When Does Paying Off Debt Hurt Your Credit?

In most cases, paying off debt helps or at least does not hurt your credit in any way. However, there are a couple scenarios where it can have a temporary negative impact:

• Paying off a very new account – As mentioned above, if you pay off an installment loan within the first year of opening it, it may not fully help establish your credit history length.

• Significantly reducing available credit – If you pay off a large loan and do not replace it with new accounts, your overall available credit will decrease. This can increase your credit utilization percentage.

• Removing your credit mix – If the paid-off loan was your only installment loan and the rest of your accounts are credit cards, your mix of credit may suffer.

However, these impacts are generally small and temporary. As long as you continue using credit responsibly, your score will quickly rebound. The positive aspects of reducing debt far outweigh any of these minor dips.

Tips to Minimize Credit Score Damage When Paying Off Debt

If you are concerned about potential temporary credit score drops, there are a few things you can do to minimize any effects:

• Do not close accounts – Leave installment loan accounts open even after paying them off to keep the credit history.

• Pay extra on newest loans first – Focus on paying off brand new loans last to allow them to age on your report.

• Open new credit first – Before paying off a large loan, consider opening a new installment loan if needed to maintain healthy credit mix.

• Lower other balances – To offset reduced total limits after debt payoff, pay down revolving account balances first.

• Stagger payoffs – Spread out paying off multiple big debts over several months to smooth impact on utilization.

• Review options to rebuild – If your score does drop, review options like becoming an authorized user to help rebuild.

The Bottom Line

While paying off debt faster than required will save you money on interest, some worry it can negatively impact their credit score. But in most cases, paying off an installment loan will actually help your score by positively influencing payment history, credit utilization, and history length.

The small, temporary credit score drops that can sometimes happen with debt payoff should not deter you. The long-term benefits of being debt-free far outweigh a minor short-term score decrease. Just be sure to maintain other credit accounts responsibly, and your score will recover quickly.