Paying off that large balance you carried for months on your credit card or making one last deposit toward your years of student loans is an unbeatable feeling. But more than just bringing you peace of mind, paying off your revolving and installment debts brings you closer to financial freedom.
Revolving credit (credit cards) is an extension of credit with an assigned spending limit but no end time to the loan, while installment credit(loans) offers borrowers a fixed amount of money over a specified period of time. No matter what kind of debt you owe, you typically have to pay interest on the outstanding balances. The sooner you can pay these debts off, the less money coming out of your pocket.
That said, acommon misconceptionis that paying off your debt always and instantly increases your credit score.It's true that getting rid of your revolving debt, like credit card balances, helps your score by bringing down your credit utilization rate. Yet, closing certain lines of credit can actually temporarily ding your credit score. Paying off your installment loans, which also includes things like car loans and mortgages, can sometimes have the opposite effect.
"It can be frustrating to see a drop in your credit score when you make a smart financial decision," says Amy Thomann, head of consumer credit education at TransUnion, one of thethree main credit bureaus.But before you get discouraged, know why it happens and how much it matters in the long run.
According to Experian,another credit bureau, there are a few reasons why your score may drop when you pay off an installment loan.
- You paid off your only installment account:Lenders like to see that you can manage a variety of different types of debts. Considering your mix of credit makes up 10% of your FICO credit score, paying off the only line of installment credit can cost you some points.
- You paid off your lowest balance account: The outstanding balances across all of your open credit accounts, or your amounts owed, makes up 30% of your credit score. If the installment loan that you paid off had the lowest balance, thus bringing down the average amount owed and leaving your only remaining active accounts with high balances, your credit score may drop.
- Something else happened: Though you paid off an installment loan and immediately saw your credit score decrease, it could just be a mere coincidence and something else caused your credit score to drop. Remember that a bunch of factors impact your score, such as applying for a loan or new credit card or racking up a high credit card balance in the meantime.
If you do experience a dip in your credit score when paying off an installment loan, know that it is likely small and only temporary.
Why you should still aim to pay off your debts anyway
Just because paying off an installment loan could ding your credit score, don't keep it open just for the sake of maintaining a high score.
You wouldn't want to pay unnecessary interest over time just to save a few points, and your 3-digit score can bounce back. The average credit score recovery time after closing an account (for those with poor to fair credit) is three months, according to Bankrate. Making a series of monthly on-time bill payments is the fastest route to improving your score. (Payment history is the most important factor.)
"Remember: your credit score is just one piece of your overall financial health,"Thomann says, emphasizing the importance of reducing interest and overall debt. "That you're making the effort to actively engage and take control of your credit health makes it more likely you'll reach your financial goals over time."
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FAQs
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.
How many points does your credit score go up when you pay off a debt? ›
If you're close to maxing out your credit cards, your credit score could jump 10 points or more when you pay off credit card balances completely. If you haven't used most of your available credit, you might only gain a few points when you pay off credit card debt. Yes, even if you pay off the cards entirely.
Will paying off a debt remove it from my credit report? ›
Once you've paid off an account in collections, it will eventually fall off your credit report. If you'd like to expedite the process, you can request a goodwill removal. Removing a paid collection account is up to the discretion of your original creditor, who doesn't have to agree to your request.
Why did my credit score drop 100 points after paying off my car? ›
Paying off something like your car loan can actually cause your credit score to fall because it means having one less credit account in your name. Having a mix of credit makes up 10% of your FICO credit score because it's important to show that you can manage different types of debt.
Why did my credit score drop when I paid on time? ›
Using more of your credit card balance than usual — even if you pay on time — can reduce your score until a new, lower balance is reported the following month. Closed accounts and lower credit limits can also result in lower scores even if your payment behavior has not changed.
Why did my credit score drop 50 points after paying off debt? ›
It's possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt. Paying off debt might lower your credit scores if removing the debt affects certain factors like your credit mix, the length of your credit history or your credit utilization ratio.
How to raise credit score 100 points in 30 days? ›
Steps you can take to raise your credit score quickly include:
- Lower your credit utilization rate.
- Ask for late payment forgiveness.
- Dispute inaccurate information on your credit reports.
- Add utility and phone payments to your credit report.
- Check and understand your credit score.
- The bottom line about building credit fast.
It can take weeks or even days for you to notice a change in your credit score. If you have recently paid off a debt, wait for at least 30 to 45 days to see your credit score go up. Will it be beneficial for my credit score if I pay off a debt? Your payment history will not be removed after you pay off a debt.
Will my credit score go back to normal after paying off debt? ›
After paying off revolving debt, your score typically recovers in a few months so long as you leave the cards open, stay under a 30 percent utilization ratio and keep up with payments. The same is true of a drop due to a credit inquiry.
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. It would also depend on the time passed since getting the negative mark.
It's a good idea to pay off your credit card balance in full whenever you're able. Carrying a monthly credit card balance can cost you in interest and increase your credit utilization rate, which is one factor used to calculate your credit scores.
What is an average credit score? ›
Most consumers have credit scores that fall between 600 and 750. In 2023, the average FICO® Score☉ in the U.S. reached 715. Achieving a good credit score can help you qualify for a credit card or loan with a lower interest rate and better terms.
Why did my credit score go from 524 to 0? ›
Credit scores can drop due to a variety of reasons, including late or missed payments, changes to your credit utilization rate, a change in your credit mix, closing older accounts (which may shorten your length of credit history overall), or applying for new credit accounts.
How to get 800 credit score? ›
Making on-time payments to creditors, keeping your credit utilization low, having a long credit history, maintaining a good mix of credit types, and occasionally applying for new credit lines are the factors that can get you into the 800 credit score club.
What is a decent credit score to buy a car? ›
Your credit score is a major factor in whether you'll be approved for a car loan. Some lenders use specialized credit scores, such as a FICO Auto Score. In general, you'll need at least prime credit, meaning a credit score of 661 or up, to get a loan at a good interest rate.
How long after paying off debt will my credit score improve? ›
If you take out a loan to consolidate debt, you could see a temporary drop because of the hard inquiry for the new loan. Your credit score can take 30 to 60 days to improve after paying off revolving debt. Your score could also drop because of changes to your credit mix and the age of accounts you leave open.
How long will it take to raise my credit score 200 points? ›
However, it'll take much longer to reach your goal if you're trying to raise your score by 200 points. Patience is key here! It may take anywhere from six months to a few years to help raise your score by 200 points depending on your financial habits.
How much will credit score go up after collection is removed? ›
There's no concrete answer to this question because every credit report is unique, and it will depend on how much the collection is currently affecting your credit score. If it has reduced your credit score by 100 points, removing it will likely boost your score by 100 points.
