Why credit scores can drop after paying off a loan

You might be disappointed to learn that wiping off debt will lower your credit score because it is a great victory. Even while seeing your credit score decline can feel like a loss, knowing why can help you come up with a strategy to raise it again. Credit scores are calculated using a specific formula and indicate how likely you are to pay back a loan on time. But while paying off debt is a good thing, it may lower your credit score if it changes your credit mix, credit utilisation or average account age.

You paid off your sole instalment loan or credit card obligation.

Your ability to manage different sorts of debt is something that creditors like to see. Your debts should ideally be split between revolving debts like credit cards and instalment debts like loans. Your score may suffer if paying off a specific obligation leaves your credit report less diverse. Your credit mix will suffer, for instance, if you pay off an auto loan and just have credit cards left.

Your overall credit use has gone up.

A higher score is obtained by maintaining a low overall credit use rate. Try to use no more than 30% of your available credit for all debts. The overall amount of credit you have available lowers after you fully pay off a credit card or revolving line of credit and cancel the account, possibly leading to an increase in your remaining utilisation rate.

The average age of your accounts has decreased.

The better, the longer your accounts have been active and in good standing. Even if you don’t use it, having a 20-year-old account on your report is a positive indicator. The average age of your accounts will be significantly lowered if you close that account and are left with accounts that are no older than five years.

Paying off debt is rarely the wrong decision, especially high-interest consumer debt. This holds true even if it causes your credit score to temporarily go down. Your financial health is more important than your credit score, especially because there’s no way to fully predict the results of each action you take.