You scrimp and save to pay off your credit card bill. You breathe a sigh of relief whenever your outstanding balance hits zero. And you check your credit score. And suddenly, things don’t seem so bright and rosy anymore. Approximately paying off the balance and checking your credit rating, something’s gone wrong. Your score is gloomier now than it was before. How is that possible? Your credit score reflects how well you manage your debt. If you’ve paid off a big balance, it should automatically improve, right? Unfortunately, no. While paying off the balance may improve things in the long term, it might not have quite the positive effect you had been hoping for in the short term. To find out why, you’ll need to understand the various factors that impact your credit score.
Why Do I Have No Credit Even After I Paid off My Credit Card?
As bankrate.com explains, there are numerous factors that decide your credit rating. Paying off debt may influence some, but not all. Your credit score covers a vast range of information, including the quantity of new credit inquiries you’ve made recently (every loan, credit card, or mortgage inquiry is noted, whether or not you ultimately proceed with the application or otherwise), your payment history, your credit mix, your credit utilization, and also the average credit account age. Many of these individual pieces of information combine to create your overall credit score. As a result, there are numerous variables at work in deciding your credit rating, even after you pay off a debt. Say you have to pay off a debt and close an account that’s been open for 15 years. The only other debt you have is against two fairly recent charge cards. By paying the debt and closing the account, you’ll effectively be lowering the average age of your accounts and cutting your credit utilization… neither of which spells good stuff for your credit score.
Understanding Your Credit Score
To realise why your credit score might drop once you pay off a balance, you need to understand how credit ratings are calculated in the first instance. Scores are calculated against five key factors, all of which carry a slightly different weight. Payment history accounts for 35 percent of your credit score. Credit utilization accounts for 30%; the age of credit accounts for 15%; credit mix for 10%; and new credit for 10%. Not all of these variables will be affected if you pay off a balance, but several will.
Your payment history accounts for the biggest portion of your credit score. Should you miss payments, your credit score will take a nose dive. If you pay off a balance, this aspect of your credit score won’t be affected.
Credit utilization is a fancy way of describing the amount of your available credit you’re currently using. It’s the 2nd most important factor after payment history in determining the way your credit score is calculated. The lower your credit utilization, the greater your credit score. As Experian notes, paying down a credit card balance lowers your credit utilization and it is thus beneficial to your credit score. However, many people mistakenly believe that closing a merchant account after paying off a balance entirely will be beneficial. It won’t, a minimum of not as far as your credit rating goes. Closing an account reduces the amount of credit you currently have available and results in your overall credit utilization increasing. After a few months, this should right itself, however in the short term, it could explain why your credit rating has dropped.
As per nerdwallet.com, a part of your credit score (10% in fact) is determined by the types, or “mix,” of credit you've. If you have both installment accounts (ie. accounts which require defined payments over a specific period, as in the case of loans and mortgages) and revolving accounts (those with no set end date and varying payment amounts, such as charge cards), your credit score will be higher than for those who have revolving accounts only. If you pay off and close an installment account while still holding credit card debt, your credit score is likely to take a dip.
Age of Credit History
The older your bank account, the more beneficial it is for your credit score. If you’ve repaid a balance on an older account and proceeded to shut it, your credit score will take a hit, particularly if you have several new accounts still open.
Each time are applying for a new line of credit, the loan check is listed on your credit report. It typically remains in your history for around 2 years before dropping off. The greater credit checks you run, the more adversely affected your score. If you made several new inquiries for credit after paying and shutting off your previous account, it might explain why your credit score has dropped.
How to Avoid Lowering Your Credit Score
While paying off a balance and closing an account may feel satisfying, it’s not always the right thing to do for your credit score. Clearing debt is less important to a stellar credit score than making promptly payments and optimizing your utilization rate. To avoid impacting your credit score detrimentally, be clever about how you pay off your debts.
Creditors like to see installment accounts over revolving accounts, so try to prioritize clearing personal loans and credit cards over student loans, car loans, and mortgages. As installment accounts will often have lower interest rates than revolving accounts, you’ll be conserving interest payments as much as you’ll be looking after your credit score. Secondly, check simply how much credit you’re utilizing. If possible, it may be worth speaking to your provider about increasing your credit card limit: providing you don’t end up maxing out the card, you should be in a position to improve your credit utilization and get your credit rating back up. Another option is to open another credit card. Although your credit card score will take a short term hit because of the hard credit check, in the long term, it’ll improve your total available credit and enhance your score accordingly. Lastly, use your experience as a warning. Paying down a balance is all well and good, but closing the account might not necessarily result in the positive impact you had been hoping for. In most cases, it’s preferable to pay off a balance but keep the account open, especially in the case of older accounts with a good payment history.