At times loan borrowers encounter some oddities related to their loans. One of the oddities is a decrease in credit score despite paid off debt. Borrower who experiences this immediately goes to their loan officer and asks “why did my credit score drop after paying off debt?” in frustration. Borrower may feel that they are being cheated by the bank. However, decrease in credit score which happens after borrower paying off their debt does not directly occur because of that reason. There are some other reasons that affect decrease in credit score after paying off debt which are going to be discussed in later part of this article.
Reasons Why Credit Score Drop Off After Paying Off Debt
Before you are asking “why did my credit score drop after paying off debt?”, you should learn how credit score is actually calculated. FICO credit score that is developed by Fair Isaac has several weighted criteria that constitute the credit score. Types of credit accounted for 10%, opening new credit for 10%, credit history length for 15%, total loan amount for 30%, and history of payments for 35%. Here is the explanation how those components will fluctuate your credit score.
- The Types of Credit
Someone who has various accounts of credit tends to have higher credit score. Accounts can be of credit cards, mortgage loans, and even retail accounts. However, it is not mandatory to have more than one credit account. Having one that you constantly utilize and adhere to will be more beneficial to your credit score than having many accounts at once that are mostly unused.
- Open New Credit Account
Some people take risks and open several credit accounts at once. It is suggested that you do not open several accounts too fast because that will shorten your credit history length. When applying for new credit, bank or lender will request for your credit score and it will affect your score although not significantly. Paying off loan often happens because you want to refinance which means opening up new credit.
- Credit History Length
Borrower that has longer credit history will earn more credit score than one that just starts using credit account. However, even if the credit history is short, good credit score is still obtainable when loan amount and history of payments are great.
- Total Loan Amount
Now, you may have started to realize the answer to “why did my credit score drop after paying off debt?” question. Paying off debt does not affect your credit score. Actually the total amount that you borrow significantly affects your credit score. So even if you are paying off debt that utilize most or nearly to your maximum loan, your credit score will decrease.
- History of Payments
Even if you have paid off your debt, when you miss payment or send it late, your credit score may decrease dramatically. Unfortunately that will stay in your history for the next seven years. Make sure that you adhere to payment deadline.
Next time your credit score decreases after paying off a debt, do not barge into your loan officer’s room asking “why did my credit score drop after paying off debt?” Learn to manage your credit accounts to avoid this situation.