For most people, credit scores are a mystery; even credit experts don't know every last thing about how credit scores are calculated -- and what makes them change. If you pay off credit card debt, for instance, will your credit score go up -- or down?
In the majority of cases, your credit score improves when you pay off credit card balances. But determining how much your credit score will change is another matter altogether. Let's take a look at what credit scoring companies consider, and how your scores can change when you pay off credit card debt.
What goes into my credit score calculation?
One of the main things that makes credit scores hard to predict is that every consumer's credit history is unique. Then factor in that credit scoring agencies don't publish their formulas.
However, though we don't have access to their exact formulas, FICO® -- the most commonly used credit scoring agency -- does publish what types of data it considers, and how much it weighs each factor.
- Payment history (35%): For obvious reasons, the most important part of your credit score is your payment history. To get the full points in this area, be sure to pay all your debts on time every month.
- Amounts owed (30%): Despite what it implies, this factor is less about how much debt you have and more about how much of your credit you're using. The ratio of your card balances to your total credit limits is called your credit utilization rate. This is the main part of your score affected when you pay off credit card debt.
- Credit history length (15%): Credit scoring algorithms -- and lenders -- want to see that you have a lot of practice handling credit. They look at the age of your oldest credit account as well as the average age of all your accounts. Older is better.
- Credit mix (10%): The diversity of your credit accounts is important, because lenders want to know you can responsibly use different kinds of credit. Your credit mix usually diversifies over time.
- New credit (10%): When you apply for a new credit account, the lender pulls your credit reports. This is known as a hard credit inquiry, and too many hard inquiries in a short time can be a red flag.
Now that we've seen what goes into your credit score, it's time to tackle how your score changes when you pay off credit card debt.
The impact to your score when you pay off credit card debt depends a lot on where you score starts. And, as you may suspect, how much of your credit card balances you pay off also influences how much your credit score changes.
If I pay off my credit card, in full, will my credit go up?
The short answer to whether your score improves when you pay off credit card debt is: Yes. The longer answer: It depends on where you started.
As we noted above, most of the credit score improvements when you pay off credit card balances come from your "amounts owed" factor. More specifically, it comes from changing your utilization rate.
Because your utilization is a ratio of how much you owe versus how much available credit you have, changing either part of the equation changes your utilization. Decreasing how much you owe -- without reducing your available credit -- decreases your utilization rate.
Here's an example: If you have a credit card with a $3,000 credit limit and a balance of $1,200, your utilization is $1,200 / $3,000 = 0.4 = 40%. If you make a payment and reduce your balance to $600, your utilization rate becomes $600 / $3,000 = 0.2 = 20%.
FICO® looks at your utilization across all of your credit cards, but they also consider the individual utilization of each card. Since lower utilization is better, reducing your utilization typically increases your credit score.
Keep in mind that a balance transfer card only reallocates your debt. It doesn't pay off credit card debt. So a balance transfer probably won't improve your credit score, though it can give you a lower interest rate. Paying off your cards with a personal or debt consolidation loan, on the other hand, can reduce your revolving debt utilization.
How much will credit score increase after paying off credit cards?
The amount your credit score improves depends a lot on how high your utilization was in the first place. If you have multiple credit cards with balances, this estimation becomes more difficult.
If your utilization rate was above 30%, your credit score could jump 10 points or more when you pay off credit card balances completely. On the other hand, if your credit utilization was already fairly low, you might only gain a few points when you pay off credit card debt, even if you pay off the cards entirely.
How long after paying off credit cards does credit score improve?
Some ways of boosting your credit can take months, or even years. Revolving debt repayment can be much faster. Given that your credit utilization ratio is the main factor impacted when you pay down credit card debt, you should see the results of those payments as soon as your credit card balances update on your credit reports.
Your credit card issuer typically sends an updated report to the credit bureaus once a month when your statement period ends. A new credit score is calculated every time your credit is pulled, and the new score uses the latest balance information.
Why did my credit score go down when I paid off my credit card?
In general, the only time you should see a decrease in your credit score when you pay off credit card debt is if you also close your account. Why? Once again, it mostly comes down to utilization.
As we saw, your credit utilization decreases when you pay off credit card balances. But this only works if your total available credit stays the same.
When you close a credit card, you lose access to that credit line. This means your total available credit decreases. If you have balances on your remaining credit cards, a decrease in your total available credit can cause your utilization rate to rise.
To avoid this, you may want to pay off credit card balances without closing your accounts. Of course, if you have problems using your card responsibly or the card has an annual fee, it may be worthwhile to close the account despite the potential impact to your utilization. In this case, try to pay off all of your credit card balances to keep your overall utilization low.
Less debt, better scores -- it's a win-win
It's always a good idea to pay off credit card debt, regardless of how that debt repayment impacts your credit scores. Unless you have an intro APR deal, any outstanding balance carried from month to month accrues interest -- at a high interest rate.
Happily, you don't have to choose between paying down high-interest debt and your credit score -- you should almost always see an improvement in your score when you pay off credit card debt. It's hard to predict how much your credit score will change, but hopefully this guide helps you estimate the potential change.
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