Did you know that when you pay off your debt, your credit score will likely drop? This was a shock to me when I began to pay off my loans, but when I took a closer look at the factors used to determine my credit score, I began to understand why.
Now some people will argue that having a zero credit score should be your goal because you should no longer borrow any money and therefore your score is no longer needed. I, however, disagree with this ideology. As someone who hopes to buy a house in the near future, it is important for me to have an excellent credit score. But when I paid off my last student loan, I noticed that my credit score dropped over 20 points. I couldn’t understand how it was possible that my score dropped so much while I was being responsible and paying off my debt. I realized that in order to understand why this happens, you have to know 5 factors that affect your credit score.
- payment history. The later you pay, the more impact this has on your score. FICO indicates that this factor accounts for 35% of your score.
- credit utilization. The amount of credit you use is called your credit utilization. Using more of your available credit results in a lower score. FICO states that credit utilization is about 30% of your score.
- age of credit history. The older your credit, the better. Most people recommend keeping old accounts open (& active) because of the impact the age of your credit has on your score. Sometimes, being added as an authorized user on someone else’s credit card can help “mature” your credit age.
- mix of credit types. A variety of credit, such as installment accounts (fixed payments through loans) and credit card accounts is recommended.
- hard inquiries. When you apply for new credit, the creditor may pull your credit history. If they do a hard inquiry, it is likely that a few points will fall off your credit score.
In my situation, my student loans were the oldest form of credit on my report. I took them out when I was 18 and didn’t have any other form of credit prior to that. So, when I paid them off, they fell off of my credit report and the average age of my credit history decreased significantly. Thankfully, as my other credit ages, this section of my report will improve. But it was a big shock to me and as more and more people are desiring to pay off their debts quickly, I think it’s important to understand how freeing ourselves financially can still potentially hold us back – even if temporarily. I’m so curious to know what were some of the unexpected things you learned while paying off your debt! Leave a comment and let’s chat!