Can Your Credit Score Drop After Paying Off a Credit Card?

Many people wonder if their credit score will drop after paying off a credit card. It's a common concern as they strive to improve their credit health. While it's possible for your credit score to drop, it usually isn't a significant issue. This article will explore the reasons behind this phenomenon and provide insights into responsible credit management.

Understanding the Impact on Your Credit Score

Reducing your credit card balance significantly lowers your credit utilization ratio, which is beneficial for your credit score. However, paying off a statement balance right before the due date can cause your utilization to spike temporarily. This is because the balance hasn't been reported to the credit bureaus by the time the next statement is sent out.

Paying off a credit card could temporarily lower your credit score due to changes in your credit utilization ratio, credit mix, and the loss of positive payment history. These effects are usually minor and short-lived but it's important to understand the nuances. The benefits of responsible credit management in the long term far outweigh the temporary drop.

Specific Situations and Their Impact

Let's look at specific scenarios to understand the impact better:

Impact on FICO Scores

If you have a clean credit report, no derogatory entries, collections, or public records, and you have multiple credit cards, paying off all cards could result in a drop of up to 20 points. On the flip side, if one card has a small balance (say, $5), paying it off could increase your FICO score by up to 20 points. This is because zero balances can indicate that you are not making regular payments, which is in contrast to the positive payment history from the other accounts.

Impact of Paying Off Installment Loans

Payoff of an installment loan, especially if it's your only one (like an auto loan, lease, mortgage, personal, or student loan), can cause a temporary drop of up to 30 points in your credit score. This is because installment loans are typically viewed positively on your credit report. However, your score should rebound within 6 to 8 months as your credit profile stabilizes with the new information.

Deciding Whether to Pay Off Your Credit Card

When deciding whether to pay off your credit card, it's important to weigh the pros and cons. If you need to get rid of a card because it's too much of a burden and you are able to do so, it might be worth it despite the temporary drop in score. Consider the benefits of having less liability and a smoother financial life.

Can You Close the Account?

Some people advise against closing a credit card account after paying it off, citing that it lowers your available credit overall, which can negatively impact your credit score. However, if the card is an expensive nuisance and you are consistently missing payments, it might be better to close it. The card might be giving you too much and acting like it's not their fault. Paying the balance helps in managing your credit health better.

Summary

While it's possible for your credit score to drop after paying off a credit card, the impact is often minimal and short-lived. Responsible credit management, including on-time payments and maintaining a healthy credit utilization ratio, is key to maintaining a strong credit score over the long term. If you find the card is cumbersome, it might be better to close it, but always consider the overall impact on your financial life.