What? Paying off a credit card can make your credit score drop?

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Published Date 1/4/2024

It feels like a bait and switch. In an effort to improve your credit, you sacrifice and work hard to pay off a credit card or two and get that liberating feeling that you're making progress. Then you check your credit score to see the effect of your admirable prudence, and you find the number has gone down, instead of up!

What you need to understand is that credit scores factor not just with the amount of debt you have; they also look at your credit utilization — the percentage of your credit limit that you're currently using. "That scoring factor is one reason your credit score could drop a little after you pay off debt," say NerdWallet's Erin El Issa and Bev O' Shea. "Having low credit utilization (30% or less) is good; having no credit utilization may be harmful to your score."

What about paying off installment loans? "Paying off an installment loan, like a car loan or student loan, can help your finances but might ding your score," they report. "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 to save some credit score points.)”

Once you've gotten your balances to zero, guard your credit by making it easier on yourself to pay on time by setting up electronic reminders, monitor your credit report for errors, and dispute any you see. Someone's file may be mixed up with yours, or your identity may have been stolen — both of which can seriously affect your score.

And just because you cleared out some debt, don't get tempted to apply for more credit products in a short period of time — whether it's the purchase of a car, furniture or to take a trip. "Opening new credit lowers the average age of your credit accounts and involves a "hard inquiry" which can result in a small, temporary drop in your score," says the two NerdWallet financial experts. "If you can, wait at least six months between credit applications."

Depending on your total available credit, it might hurt your score to completely close a credit account with a high credit limit. The fact that you have been offered a lot of credit means you have demonstrated proficiency, and that credit utilization thing comes into play again. To make sure closing one card doesn't impact your score, pay off balances on all other cards.

And lastly, if you've just qualified to buy a home and are waiting to close escrow, this is NOT the time to buy furniture on credit, especially if your qualifying ratios are borderline. Before making any large purchases on credit, consult your loan officer. There will be a final credit check before you close, and if your number has gone down, you may risk getting your approval nullified.

Source: NerdWallet, CreditCards.com, TBWS

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