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.
Having collections accounts on your credit report can significantly damage your credit scores. So you may think that paying off collection accounts would boost your scores However, you might see the opposite effect – your scores dropping after paying off collections.
This counterintuitive outcome can be frustrating and confusing. Here, I’ll explain why paying off collections could lower your scores and what you can do about it.
How Credit Scores Work
To understand why paying collections could drop your scores, it helps to know what goes into calculating credit scores. Scores like FICO and VantageScore are based on the information in your credit reports from Equifax, TransUnion, and Experian.
Several main factors determine your scores
- Payment history – Have you paid your bills on time? Late payments can hurt.
- Credit utilization – What percentage of your total credit limits are you using? Higher utilization can lower scores.
- Credit age – How long have you had credit? Older accounts help raise scores.
- Credit mix – Do you have different types of credit – revolving like credit cards and installment like auto loans? Mix helps.
- New credit – Opening new accounts may indicate higher risk and lower scores temporarily.
With this context, let’s look at how paying collections could impact these key factors and your scores.
Why Scores May Drop After Paying Collections
Here are three reasons your credit scores may drop, even if only temporarily, after you pay off collection accounts:
1. Your Credit Mix Declines
Credit mix refers to having different types of credit – installment loans like mortgages and auto loans, and revolving credit like credit cards. Lenders like to see you can manage different types responsibly.
If a paid collection was your only installment loan, removing it decreases your mix. Less mix diversity can lower scores.
2. Your Credit History Length Shortens
Length of credit history carries significant weight in credit scoring. Older accounts show you have a longer track record of responsible credit management.
When you pay a collection, the account typically gets removed from your reports. This can lower your average account age and history length, negatively affecting scores.
3. Your Utilization Ratio Increases
Utilization ratio means how much of your total credit limits you’re using. Owing $5,000 on a $10,000 limit means 50% utilization. High ratios can hurt scores.
Paying and closing a collection lowers your total limits. So your utilization on remaining accounts may increase, lowering scores.
How to Minimize Score Damage
While counterintuitive, a small drop in scores after paying collections isn’t a cause for concern. The benefits of clearing collections far outweigh a minor hit. However, you can take steps to minimize potential damage:
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Pay down balances on other credit cards and loans. This lowers your utilization ratios across accounts.
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Leave old paid accounts open if possible. Don’t close them – keeping the age and history helps scores.
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Spread out payments over several months. Staggering payments may soften the scoring impact versus one lump payoff.
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Give it time. Any scoring drop is likely temporary. As you build positive history, your scores will rebound.
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Get added to an authorized user account. Becoming an authorized user on a spouse or family member’s old account adds to your history length.
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Request goodwill deletion for paid collections. You can ask collectors to remove paid collections from credit reports, preserving your history.
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Get your reports corrected. Make sure no errors make the drop worse. Dispute any inaccuracies with the credit bureaus.
Long-Term Benefits Outweigh Temporary Dips
Seeing your credit scores decrease after paying off collections can be confusing and concerning. But keep the big picture in mind. Settling collections accounts helps improve your credit standing and eligibility for new credit in the long run.
Any temporary drop in scores will likely correct itself within a few months as you continue building positive history. And a small drop is a minor price to pay for removing harmful collections from your reports. The long-term score boost from getting out of debt far outweighs short-term dips.
Be patient, continue smart credit management, and your scores will rebound. Paying collections puts you on the right track to credit health and recovery over time. The small initial score decrease is a slight valley on the journey up to higher scores.
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.
Why might my credit scores drop after paying off debts?
Paying off debt might lower your credit scores if removing the debt affects certain factors such as your credit mix, the length of your credit history or your credit utilization ratio.
For example, paying off your only installment loan, such as an auto loan or mortgage, could negatively impact your credit scores by decreasing the diversity of your credit mix. Creditors like to see that you can responsibly manage different types of debt. 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. This is because your total available credit is lowered when you close a line of credit, which could result in a higher credit utilization ratio. Additionally, if the account you closed was your oldest line of credit, it could negatively impact the length of your credit history and cause a drop in your scores.
Why Your Credit Score DROPPED After Paying Off Debt!
FAQ
Why did my credit score go down when I paid off collections?
Credit utilization — the portion of your credit limits that you are currently using — is a significant factor in credit scores. It is one reason your credit score could drop a little after you pay off debt, particularly if you close the account.
Why has my credit score gone down after paying off debt?
Yes, this is normal. This happens because of how your credit score is calculated. How many open lines of credit you have open plays a large part in that calculation, and because you payed off those loans, thus closing those lines of credit, the calculation gets affected in such a way that your score goes down.
Does paying off collections lower your credit score?
Paying a credit card debt collector typically won’t cause your credit score to drop.Nov 21, 2024
Will my credit score go back up after collection is removed?