A surprising consequence of paying off debt may be a drop in your credit score. This happens because open accounts play a large part in determining your score.

It’s important to understand which factors are involved in determine your credit score. The factors include both positive and negative information from your credit reports.

Payment History

Your payment history shows whether you’ve consistently made on time payments. This helps lenders determine the amount of risk involved when extending credit.

Credit Utilization

Credit utilization measures how much credit you are using compared to your total available credit. Lenders look at this number to find out how much you are relying on credit. The lower the number the better. Most financial experts recommend that you keep your utilization below 30% but 0% is ideal, you can accomplish this by paying your balances in full every month by the due date.

Credit Age

This is the length of your total credit history, having long-standing accounts is beneficial. This is one reason most financial experts recommend you keep old credit card accounts open even if you don’t use them often, another reason not to close old accounts is because it can temporarily lower your credit score.

New Accounts & Credit Checks

When you apply for a new line of credit your credit is pulled to determine your eligibility. There are hard and soft inquiries. Hard inquiries typically occur when a financial institution checks your credit when making a lending decision, for example when applying for a mortgage, loan or credit card, while one hard inquiry may not have a huge impact on your credit score having multiple hard inquiries close together can lower your score significantly. Soft inquiries are typically used for things like employment, rental housing, and pre-approved loan and credit card offers, they do not have a negative impact on your score.

Credit Mix

Credit mix is used in determining your credit score, having a good mix of credit with accounts that are in good standing is beneficial, this can include credit cards, home and auto loans, and personal loans. A diverse credit mix tells lenders that you have been able to manage different types of credit accounts responsibly over time.

When you pay off debt your score can drop for several reasons. One reason is that if you close an account, you no longer have that credit history. Long standing accounts play a factor in your score and if that account is no longer open it will decrease the age of your credit history.

Closing an account will also raise your credit utilization, a closed account leaves you with less available credit.

Closing an account will also decrease your credit mix.

Don’t let this stop you from paying off debt. There is no greater feeling than being debt free and you should not hang onto debt just to maintain a credit score. Credit scores fluctuate and you can take steps to increase your score.

  • Pay your bills on time.
  • If you have paid off a credit card, consider keeping the account open unless there is a compelling reason to close it like an annual fee or a high interest rate. Use the card just a few times a year for a necessary expense like gas or groceries or use it to pay a monthly bill. This will keep the account from being closed due to inactivity and it will keep the card in your credit mix.
  • You can also ask your credit card company to increase your credit limit which will decrease your credit utilization rate. If you are in good standing with your credit card company, they will most likely raise your limit if you ask.
  • Check your credit reports regularly, errors on your credit reports may contain negative information that can lower your score.
  • Be careful applying for multiple credit products at one. When you apply for credit, the creditor will perform a credit check, and hard inquiries can result in a temporary drop in your credit score.