Why Did My Credit Score Drop After I Paid Off Debt?

Whether you paid for a dream honeymoon, made an emergency personal loan 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 and what are a few credit score hacks you can use?

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 and a few helpful financial health tips.

Credit Mix Matters for Your Credit Score

Your credit score s an important factor that 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 credit utilization 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:

• Fixed-term, secured installment accounts (e.g., mortgages or auto loans)
• Fixed-term, unsecured installment accounts (e.g., student loans or personal loans)
• Unsecured, revolving accounts (e.g, credit cards or store charge cards) with low balances

What Can Happen After You Pay Off Your Loan

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 paying off debt:

• If you only have debt on revolving accounts (that allow you to borrow over and over), it’s more difficult for credit agencies to tell if you’re using credit responsibly or treading water.
• If after paying off your loan you happen to apply for new credit, depending on your timing, it can be viewed as a sign of a negative turn in your finances.

> Pro Tip: Once your loan is paid off, take a look at your credit report as it 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.

The #1 Way to Give Your Score a Boost

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.

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.

Keep Making Credit Savvy Choices

Along with common sense and good financial habits, here are a couple of extra pointers that can help you maintain a high score:

• If you’re planning to apply for a car loan, mortgage, or even a credit card, consider doing it right before or immediately after you pay off your personal loan or joint personal loans, before the installment payments disappear from your credit report.
• If you must make a large purchase on credit, consider using a personal loan instead of a credit card (where there’s a greater risk of carrying a balance). Having an installment loan and paying it on time every month will boost your credit 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 and continue to grow your savings.

Interested in learning more? Check out these related blog posts:

• How to Build Your Business Credit
• Should You Pay Off Credit Card Debt During a Recession?
• The Smartest Way to Close a Credit Card Without Dinging Your Credit
• How to Opt Out of Black Friday Spending