Why did my credit score drop after paying off the debt?

Dear Account Manager,

I redeemed my Amex balance and TransUnion reduced my score by 41 points. Credit card usage increased from 84 percent to 1 percent. Why did my rating go down? I also paid off the balance on my Capital One card and Home Depot loan. Will TransUnion lower my grade even more after the last two come? — Andrey

Dear Andrew,

Don’t we all want the world of scoring to be that simple? Press button A and your score goes up, press button B and it goes down. In the real world, estimates are based on complex algorithms that can predict more than even the trained eye can see.

However, that doesn’t seem right, does it? Here you are doing what seems right, and you are being punished! Let’s look at this a little closer to see if we can figure out what’s going on.

Why Paying Off Debt Can Hurt Your Credit

It seems counterintuitive, but paying off debt can hurt your credit. Here are a few scenarios you can consider:

Does your Amex account have a set credit limit? Some Amex cards work like traditional revolving credit cards – they offer a set credit limit and affect the credit utilization per se. But other Amex cards do not have a set credit limit (instead, you can enroll in the Pay Over Time program for select qualifying purchases if you need to keep your balance). Without a predetermined limit, these cards will not affect your usage rate. If this applies to your Amex card, the 41 point drop could be due to something else.

Have you closed your account? If you close a revolving account after you have paid it off, it could hurt your account because it will lower your overall credit limit. If you did (or closed any other account), that explains the drop, as your total credit limit across all your credit cards counts towards your credit utilization ratio.

Do you have a very high score to start with? Any changes in your credit behavior can negatively impact a high score, at least in the short term. If you dropped 41 points from 840 to 799, there really is no practical difference between the scores.

There may be additional reasons why your score has dropped, but this does not necessarily mean that you have credit problems. For example, it may take 30 days before your lower balance appears in your credit. If it hasn’t been that long, give it time. The 41 point drop could be the result of your previous 84% ​​leverage ratio.

Finally, it’s always good to remember that you have multiple credit scores and each one is unique. If the two scores you see are from different lenders or third party websites, the drop may have nothing to do with your credit habits. This may simply be the result of different scoring patterns.

FICO scores and VantageScores use similar information to calculate credit scores, but this information is weighted slightly differently. As such, the valuation you see on a third party website will most likely be slightly different from the one used by the lender.

How long does it take for a credit rating to change after debt is repaid?

After you pay off the debt, it can take 30 to 45 days for the payment to show up on your credit report. The delay between paying off your debt and showing it on your credit report is due to the monthly creditor reporting process and credit card and loan billing cycles.

The positive effect that you can get from debt repayment usually affects your credit score within one to two months after paying off the debt, but the positive effect is not always guaranteed. In some cases, your credit score may deteriorate temporarily after you pay off your debt. But, as a rule, this is only an initial drop, and usually it is limited to those who close the account or whose account is closed by the creditor after the debt is paid off. However, for those who repay their debt and keep their account open, debt repayment should lead to an increase in credit score.

How to pay off debt

Paying off debt is, in my humble opinion, one of the best things you can do for yourself. This is definitely a good move for your financial health and I believe it will also help your overall health. When it comes time to pay off debt—whether it’s revolving debt (like a credit card) or an installment loan (like paying for a car)—you need to know you’re doing what’s right for you, and your score will reflect your good behavior in the long run. perspective.

Here are some of my favorite debt reduction methods:

• Set a fun goal. Paying off debt may not be much fun, but it’s always easier if you do it for a reason. Making a plan for the money you will eventually free up can help motivate you to pay it off faster.
• Set a time frame. Take a look at your budget and determine how much you can reasonably set aside to pay off your debt each month. Then, using the debt calculator, you can set a specific date for debt relief.
• Do it automatically. Once you decide how much you can set aside each month to pay off your debt, set up monthly automatic payments to keep up with your schedule.

And remember, when it comes to credit cards, it’s best not to close them unless there’s a good reason to do so (like an annual payment you think is too high or poor customer service). If the card has a high interest rate and you think that is a good reason to close it, I would advise you to only use the card for purchases that you can pay in full every month, or just put it in a drawer and get a new card with more low or zero starting annual interest rate for other purchases. It’s a win-win in my book.

How to increase your credit score

If you decide to pay off your debt and this is negatively impacting your credit score, there are steps you can take to try and get your score back in shape. To improve your credit score after you pay off your debt, it may be helpful to consider the following steps:

• Make consistent and timely payments on all bills to avoid late payments that damage your credit.
• Diversify your loan portfolio with installment loans and revolving loans.
• Reduce your credit utilization rate to less than 30 percent, ideally 10 percent if possible.
• Look for new loans that can increase your overall loan pool or diversify your portfolio.
• Maintain a minimum credit card balance to demonstrate responsible use of your credit, and try to avoid closing old credit card accounts unless annual or monthly fees make them too expensive.

Don’t forget to keep track of your score! To keep track of your progress in improving your credit score, it can be helpful to sign up for a credit monitoring service that will alert you to changes in your credit score.

Steve Bucci has been helping people decipher and solve personal finance problems for over 20 years. He is the author of The Dummies’ Credit Management Kit, The Dummies’ Credit Repair Kit, Barnes and Noble Debt Management, co-author of The All-In-One Your Money Management Kit, and The Credit Repair Kit. For Dummies (Australia). Steve is an experienced expert witness in identity theft, credit scoring and debt cases. He has been a speaker at the FICO InterACT Global Conference, the Federal Reserve and the International Credit Symposium at the University of Cambridge in the UK.