Making a final debt payment can feel freeing, but it won’t necessarily bump up your credit score. Worse, it can actually cause a dip in your score, as counterintuitive as that may be.
Why would my credit score drop after paying off debt?
Creditors want you to repay them when they lend you money, so it seems reasonable that paying off debt would help your credit score. But that's not exactly how credit formulas work.
There are many factors that affect credit scores, including:
Payment history.
Credit utilization (how much of your credit limits you're using).
The length of your credit history.
Credit mix.
How recently you’ve applied for new credit.
Paying off your debt, such as a loan or credit card, can impact some of these factors. Here’s why paying off debt might cause a credit score to drop, and how soon it might recover.
It could raise your credit utilization
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. Having low credit utilization (30% or less) is good, and the lower the better.
Usually, paying off a credit card helps lower your credit utilization because your remaining balances are a smaller percentage of your overall credit limit. But if you close the account you just paid off, you lose that account's credit limit and now your other balances represent a greater percentage of your total limit.
It could lower the average age of your accounts
Credit score calculations favor longer credit histories. The most commonly used score, FICO, continues to include the age of your closed accounts in its scores. But rival VantageScore may not. If you paid off a car loan, mortgage or other loan and closed it out, that could reduce your age of accounts in VantageScore's calculations. That's also true if you paid off a credit card account and closed it.
It might reduce the types, or 'mix,' of credit you have
Scores reward you for having both installment accounts (with set payments over a specific time, like a loan) and revolving accounts (with varying payments and no set end date, such as credit cards).
Let's say you just made the final payment on your car loan. Your payment history is perfect and you keep credit card balances low. 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.
It's smart to keep on top of the factors that influence your credit score, and it's easy to automate. NerdWallet can show you where you stand with credit score factors and how your score is responding. NerdWallet updates your free credit information weekly.
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How to pay off debt and help your credit score
Focusing on credit card debt first can help your budget because cards tend to have higher interest rates than installment loans. It also helps your score by lowering your credit utilization.
Credit utilization is calculated both on a per-card and overall basis. If you have any credit cards that are anywhere close to their limits, make it a priority to lower those balances to no more than 30% of your limit — and lower is better.
Keep these credit-building habits in mind:
Pay on time, every time. Late payments can seriously damage credit.
Keep credit cards open unless you have a compelling reason for closing them, such as an annual fee or poor customer service. When you close an account, it can reduce your average account age. It also cuts your available credit, which sends utilization up.
Use credit lightly. If you no longer love the card, consider putting a small, recurring charge on it, and putting it on autopay. That way you don't miss paying the bill, and the issuer won’t close the card because of inactivity.
Take an overall view of installment loans. Don't keep an installment loan open just to avoid score damage — you're costing yourself unnecessary interest.
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How long does it take credit scores to go up after paying off debt?
The timing of credit score changes depends on when your account activity is reported to the credit bureaus. Creditors typically share information with the bureaus monthly.
Whether paying off debt causes your score to go up or down, you should see a change within about a month or two after paying off debt.
How do I keep my credit score from dropping?
Some simple steps can help protect your credit from unexpected dips.
Make it easier to pay on time. Set up reminders to pay bills. You can set up calendar reminders, or get emails or text alerts from most issuers.
Watch for credit report errors. Any attempt to build your credit will be fruitless if the data going into your scores is wrong.
You can get free credit report information two ways: Some personal finance websites and credit card issuers offer report information. And you’re entitled to a free report directly from the credit bureaus.
The reports you can get weekly from the three credit bureaus can run to dozens of pages.
If you see an error, dispute it. Someone else’s file mixed up with yours or identity theft could potentially — and unfairly — hurt your score. The sooner you address that, the better.
Don’t apply for multiple credit products in a short time. Opening a new credit account lowers the average age of your credit accounts and involves a hard inquiry, which can result in a small, temporary drop in your score. If you can, wait at least six months between credit applications, and do your credit card research before you apply.
Practice patience. Sometimes the best thing you can do for your credit is wait. In the case of a positive, like paying off an account, see if that initial dip eventually fades away. And in the case of missteps, such as a missed payment, most negative marks fall off your credit records in seven years.
» MORE: Use NerdWallet's free credit score simulator to learn how money moves could affect your credit — and get your free score, too.
