A big influence on your credit score is credit utilization — the percentage of your credit limit that you are currently using. That scoring factor is one reason your credit score could drop a little after you pay off debt. Having low credit utilization (30% or less) is good; having no credit utilization may be harmful to your score.
Credit utilization is one reason your credit score could drop a little after you pay off your debt.
Some of the other factors that affect your credit score also could come into play. Paying off an installment loan, like a car loan or student loan, can help your finances but might ding your score. That’s because it typically results in fewer accounts. (That’s not a reason not to do it! Don’t stretch out a loan and pay more in interest just to save some credit score points.)
Age of your credit accounts, whether you’ve recently applied for credit and what kinds of credit you have also can affect your score. Here’s a breakdown of the factors that affect your credit scores in order of importance:
How to pay off debt and help your credit score
If you focus on credit card debt first, it can help your budget (cards tend to have higher interest rates than installment loans) and your score too (if you lower your credit utilization).
Credit utilization is calculated both on a per-card and overall basis. If you have any credit cards that are charged up to anywhere close to their limits, make it a priority to lower your balance(s) to no more than 30% of your limit — and lower is better.
Here are other habits to keep in mind:
- Pay on time, every time. Late payments can seriously damage credit.
- Keep credit cards open. That is, unless you have a compelling reason for closing them, such as an annual fee or poor customer service. When you close an account, it can reduce your average account age. It also cuts your available credit, which sends utilization up.
- Use credit lightly. If you no longer love the card, consider putting a small, recurring charge on it, and putting it on autopay so that the issuer won’t close the card because of inactivity.
How do I keep my credit score from dropping?
Once you’ve gotten your balances to zero, here’s how to guard your credit.
Make it easier to pay on time. Set up reminders to pay bills. You can set up calendar reminders, or get emails or text alerts from most issuers.
Watch for credit report errors. Any attempt to build your credit will be fruitless if the data going into your scores is wrong.
You can get free credit report information two ways: Some personal finance websites, including NerdWallet, offer report information on demand. And once a year you’re entitled to a free report directly from each of the three credit bureaus.