Whether you paid for a dream honeymoon, made an emergency home repair, or consolidated your credit card debt, paying off your personal loan balance is a big accomplishment. It also shows you’re able to responsibly manage your credit. So, why did your credit score drop?
Don’t worry, most likely it’s only temporary. To understand why, let’s take a look at the complicated way credit scoring agencies determine credit scores.
Your credit score helps lenders determine how likely you are to make timely payments on the money they lend you. Since your credit score doesn’t take into account your salary or income, credit scoring agencies view installment loans that are in good standing as a strong indicator of steady income, and most importantly, the ability to make regular, on-time payments. So, it’s this combination of the different types of loans and credit accounts you have, called your “credit mix,” that plays a big part in how your score is calculated. In fact, VantageScore ranks credit mix as a highly influential factor in determining credit score—more important than total amount of debt owed.
For example, those with the highest credit scores typically have a solid history of making payments on time and a healthy mix of credit accounts, such as:
Once you pay off your personal loan, your lender reports it and stops sending the credit agencies monthly updates about your account. Since the credit agencies now have less information about you to work with, all else remaining equal, suddenly having no installment debt may (temporarily) cost you some points.
That’s because ongoing data about the progress you’re making on fixed loan payments contributes to your overall picture of financial stability. So, if that personal loan was your only installment account, you may look like a slightly bigger credit risk now than you did before.
While every credit profile is different, here are a couple of other reasons that could cause a credit score drop after loan payoff:
> Pro Tip: Once your loan is paid off, your credit report may show the account as “fully paid” or “closed.” But these distinctions aren’t necessarily what’s driving your credit score. Instead, your score is more likely affected by the fact that your account is no longer active or open. If you have specific questions about your credit score, contact FICO to learn more about what impacts your score, and what you can do about it.
It can be frustrating to see your credit score drop when you know your financial situation has actually improved. Stay the course and be patient. As long as you continue to maintain a mix of credit accounts and history of making on-time payments, most likely it will be only a temporary setback.
To gain points on your credit score as fast as possible, the number one thing you can do is take the money you used to make that monthly loan payment (yes, the one you just paid off)—and put that same amount toward paying down other debt.
If you do this, you’ll improve two of the other factors in your credit score: total amount owed and credit utilization. According to VantageScore, total amount owed is moderately influential to your credit score, while credit utilization, the proportion of money you owe to your available credit, is highly influential.
Along with common sense and good financial habits, here are a couple of extra pointers that can help you maintain a high score:
Now that you understand more about how credit bureaus and lenders look at your financial behavior, you can make better decisions that put your financial picture in the best possible light.
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