- Your credit score may go down after paying off a loan or a credit-card balance.
- When you pay off an old loan and the account closes, it may affect your credit history, though the account will remain on your credit report for at least seven years, according to credit-reporting agency Experian.
- When you pay off a credit-card balance, avoid canceling the credit card altogether, because that can affect your credit utilization.
- Ultimately, the long-term benefit of paying off debt outweighs any temporary hit to your credit score.
- Visit Business Insider’s homepage for more stories.
Finally paying off debt that you’ve been chipping away at for months or even years feels really good.
But if you’ve ever been there, you know that wiping out a loan or a big credit-card balance can temporarily lower your credit score. It seems like a cruel trick — after all, isn’t debt the mortal enemy ofexcellent credit?
It is, but there are a few more important factors in the mix.
- 35% payment history
- 30% current debt balances
- 15% length of credit history
- 10% new credit
- 10% credit mix
Paying off credit-card debt or closing the account altogether can affect credit utilization
Accounts listed on your credit report include not only credit cards but any “installment loans” you have, including student, home, auto, and personal loans.
The longer an account is open, the better it is for your credit score. If you consistently make on-time payments on long-standing accounts, you’re probably in great shape creditwise.
When it comes to credit cards, your credit-utilization ratio — the percentage of your total credit limit that you’re using — also has a very high impact on your credit overall. Experts recommend aiming for 10% to 30%. When you have outstanding credit-card debt, that ratio is likely to be higher. But when you pay off your balances, it goes down.
Even if your credit score drops slightly after paying off a credit-card balance, it won’t last long. As long as you don’t close the account altogether and you continue making on-time payments for any new balances, your score should neutralize, and ultimately rise, in no time.
Closing an active account can have a negative impact on your credit history
Unlike a credit card, when you make the final payment on a loan, the account will be automatically closed.
“Paying off an installment loan, particularly a large one like a car loan or mortgage, can have an initial negative impact because it creates instability in the credit history,” Rod Griffin, director of consumer education and awareness at Experian, told Business Insider.
However, according to Griffin, an installment loan account and its payment history will remain on your Experian credit report and contribute to your credit history for 10 years after it is paid off and closed, as long as there is no delinquency on the account. If there are delinquencies, Experian will keep the account on your credit report for seven years from the original delinquency date, Griffin said.
A temporary hit to your credit score is no reason to avoid paying off debt
Credit-scoring agencies also look at something called your credit mix, though it’s usually not a determinant of your credit score.
If you have five credit cards, a mortgage, and an auto loan, you have a good mix of different types of credit. Paying off one of those loans may reduce your variety of credit.
All that said, anticipating a temporary hit to your credit score is no reason to avoid paying off debt. Current debt balances — including debt you owe and debt you pay off each month — account for some 30% of your overall credit score, so paying them off has a much greater benefit in the longer run. Plus, the longer you drag out your debt, the more you’ll hand over in interest payments.
Editor’s note: An earlier version of this story erroneously stated that paying off an installment loan will immediately remove the account and its history from your credit report. It has been updated to clarify that a loan account may remain on a credit report for up to 10 years.