A credit card can be a great way to break large purchases into smaller, more manageable payments. However, carrying a credit card balance from month to month isnt generally the smartest option.
Paying off debt is usually seen as a positive financial move. However, some people worry that paying off an installment loan like a mortgage or auto loan early might hurt their credit score. So does paying off debt in full negatively impact your credit?
It doesn’t hurt your credit score to pay off your debts in full. In fact, paying off your debt can often help your credit score go up. Here’s a more in-depth look at how it does that.
How Paying Off Debt Impacts Your Credit Score
To understand how paying off debt impacts your credit score it helps to first understand what makes up your credit score. The three major credit bureaus (Experian, Equifax and TransUnion) use proprietary scoring models to calculate your credit score. But the most commonly used model is the FICO score, which weighs the following factors
- Payment history (35%) – Your track record of on-time payments on all credit accounts.
- Amounts owed (30%) – Also called credit utilization ratio. Measures how much of your available credit you are using.
- Length of credit history (15%) – How long you’ve had credit accounts opened.
- New credit (10%) – Number of new credit accounts recently opened.
- Credit mix (10%) – Mix of different types of credit accounts – installment loans, credit cards, etc.
Now let’s look at how paying off debt can impact some of these key factors
Payment History
If you pay off an installment loan early, it won’t hurt your credit score. This is very good for your credit score because payment history makes up more than a third of it.
It doesn’t matter if the loan was late or delinquent before you paid it off; paying it off won’t hurt your payment history. Any late payments will show up on your credit report for up to 7 years. Getting rid of the debt won’t make the problem go away, though.
Credit Utilization
Paying off installment debt – especially large loans like a mortgage – can dramatically reduce your overall credit utilization. This ratio makes up 30% of your credit score, so lowering it by eliminating debt can give your score a nice boost.
For example, if you have a $100,000 available credit limit across all cards and loans, and $85,000 of that is being used, your utilization is 85% – considered very high. But if you pay off a $50,000 mortgage, your utilization instantly drops to 35% just by eliminating that debt.
Credit History
One myth about paying off loans early is that it can shorten your length of credit history. However, this is not true – your credit report will continue to show those accounts for 10 years after they are closed. Having a strong history of long-open and paid-off accounts actually strengthens your score.
One time this isn’t true is if you pay off an account in the first year it was opened. Your credit score doesn’t fully take into account new accounts until they are 12 months old. This means that paying off very new debt can get rid of it before it helps your history length.
New Credit
Paying off debt does not count as applying for new credit, so it does not impact the new credit portion of your score at all. This is only affected when you open new accounts.
When Does Paying Off Debt Hurt Your Credit?
In most cases, paying off debt helps or at least does not hurt your credit in any way. However, there are a couple scenarios where it can have a temporary negative impact:
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Paying off a very new account – As mentioned above, if you pay off an installment loan within the first year of opening it, it may not fully help establish your credit history length.
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Significantly reducing available credit – If you pay off a large loan and do not replace it with new accounts, your overall available credit will decrease. This can increase your credit utilization percentage.
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Removing your credit mix – If the paid-off loan was your only installment loan and the rest of your accounts are credit cards, your mix of credit may suffer.
However, these impacts are generally small and temporary. As long as you continue using credit responsibly, your score will quickly rebound. The positive aspects of reducing debt far outweigh any of these minor dips.
Tips to Minimize Credit Score Damage When Paying Off Debt
If you are concerned about potential temporary credit score drops, there are a few things you can do to minimize any effects:
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Do not close accounts – Leave installment loan accounts open even after paying them off to keep the credit history.
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Pay extra on newest loans first – Focus on paying off brand new loans last to allow them to age on your report.
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Open new credit first – Before paying off a large loan, consider opening a new installment loan if needed to maintain healthy credit mix.
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Lower other balances – To offset reduced total limits after debt payoff, pay down revolving account balances first.
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Stagger payoffs – Spread out paying off multiple big debts over several months to smooth impact on utilization.
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Review options to rebuild – If your score does drop, review options like becoming an authorized user to help rebuild.
The Bottom Line
While paying off debt faster than required will save you money on interest, some worry it can negatively impact their credit score. But in most cases, paying off an installment loan will actually help your score by positively influencing payment history, credit utilization, and history length.
The small, temporary credit score drops that can sometimes happen with debt payoff should not deter you. The long-term benefits of being debt-free far outweigh a minor short-term score decrease. Just be sure to maintain other credit accounts responsibly, and your score will recover quickly.
What is credit utilization?
Your debt-to-credit ratio, which is another name for your credit utilization rate, shows how much revolving credit you’re using compared to the total credit you have access to. Revolving credit accounts include things like credit cards or lines of credit where you can reuse credit (up to a predetermined limit) as you pay your balance down. Lenders may look at this ratio, which is usually given as a percentage, as one of several things they use to figure out your credit score.
Most prospective lenders are looking for a debt-to-credit ratio at or below 30%. A lower ratio could mean that you are a responsible debtor, while a higher ratio could mean that you are a risk and cause your credit scores to drop.
How credit utilization impacts your credit
When you make a large purchase with your credit card, your credit utilization rate generally increases. As you work to pay off the balance due on the money youve borrowed, the ratio will then usually decrease.
If youre carrying a balance on your credit card from month to month, youre increasing the odds that additional purchases will tip you over the 30% credit utilization rate that lenders like to see. When this happens, its likely that your credit scores will be negatively affected.
Whats Better For Your Credit Paid In Full or Settled for Less
FAQ
Does your credit score go down if you pay in full?
It’s possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt. Paying off debt might lower your credit scores if removing the debt affects certain factors like your credit mix, the length of your credit history or your credit utilization ratio.
Is paying in full good for credit?
It will make no difference to your credit score whether you pay in full, or pay the minimum.
Is it bad if I pay my credit card in full?
If you always pay your full statement balance by the due date, you will maintain a credit card grace period and you will never be charged interest. May 28, 2024.
Will a paid-in full collection help my credit score?
… collections: VantageScore 3. 0 and 4. 0 do not penalize paid collections, so those scores will be positively affected if you pay a collections account in fullJan 7, 2025.