Can Your Credit Score Drop For Being A Good Payer?
“No good deed goes unpunished.” Collecting quotes is a hobby of mine. A good quote that crystallizes a complex idea into one tidy phrase comes in handy for a freelance writer often. Consider your credit score. Did you know that you will probably see your credit score drop like an anchor at sea if you responsibly pay off your debts?
Why would you experience a credit score drop if you’re financially responsible enough to pay all of your bills on time and in full?
The operational nature of a credit report is predicated on the assumption that you will always maintain some form of debt.
Credit bureaus are businesses with business models. They’re dependent upon you maintaining:
- Credit card accounts (Don’t cancel or close credit card accounts)
- Non-credit card related debts
- 30% credit utilization ratio
For a credit bureau to calculate a credit score, you must have a history of responsibly paying debt.
And then continue doing so.
I will list some examples where paying off debt will result in a credit score drop.
It’s important to keep in mind that there may not be much you can do to prevent a credit score drop. It’s not the end of the world.
First, let’s make sure we’re all on the same page when it comes to credit scores.
Your Credit Score and You
The best way to understand why you can experience a credit score drop is to understand your credit score.
And, how its calculated.
A credit score is a 3-digit number that bureaucratically reflects your creditworthiness.
Credit card companies, employers, financial lenders, and mortgage lenders refer to your credit score before making a final decision.
The credit score metric as we know was developed by FICO decades ago.
Over 90% of financial lenders use FICO credit scores to make their decisions.
Here’s how credit scores are categorized:
- Poor – 300 to 579
- Fair – 580 to 669
- Good – 670 to 739
- Very Good – 740 to 799
- Excellent – 800 to 850
Here is how your credit score is calculated:
- Complete payment history (35%)
- Credit utilization (30%)
- Length of credit history (15%)
- New credit (10%)
- Type of credit (10%)
OK, so now that we know that, why is it that you can get penalized for paying debts off?
It depends on how you do it.
Credit Card Accounts
Paying off a credit card and closing the account can cause a credit score drop.
You credit score is calculated using data according to the amount of credit cards you possess and how long they stay active.
Your credit score history began when you received your first credit card. It continued as you applied for subsequent cards.
Paying off a card, and then closing it, will cause more trouble than its worth.
You are deleting vital data that affects your length of history and score.
Some credit cards automatically cancel themselves if they are idled for significant periods of time. Stay vigilant.
If you’ve paid up an account, use the card to pay for dinner or other small purchase every other month.
You don’t need to create new, significant amounts of debt to keep the card active.
There is no need to apply for any other cards but closing existing accounts won’t help your credit score.
Non-Credit Card Related Debt
Credit card related debt are not the only kinds of debt that show up on your credit history.
Paying down non-related credit card debt creates instability in your credit history.
Your credit card debt automatically rolls over to the month.
Installment loan debts, like a mortgage, business loan, or car loan, are paid out over time on a finite schedule.
After you finished paying your mortgage, the payment history is closed on your credit report.
You may see a credit score drop as a result. However, its not the end of the world.
Paying off installment loan debt will only cause a temporary credit score drop. It will incrementally rise as you pay off your other debts.
30% credit utilization ratio
Another way to see a credit score drop after responsibly paying down debt is to access too much of your available credit line.
Remember, over 30% of your credit score is calculated via your credit utilization ratio.
If you have multiple credit cards, significant debt, and pay them all off over time, your credit utilization ratio increases.
Then, you’ll see your credit score drop.
Try not to max out every credit card you have. Access less than 30% of your collective credit line.
The more you access your credit line, the less creditworthy you’ll seem to a credit bureau or potential lenders.
Lower your overall debt load and your credit utilization ratio will lower over time. Likewise, your credit score will increase over time.
Credit Score Drop Avoidance
Remember, paying off your personal debt is an integral part of the credit bureau business model.
It can still get you penalized.
Don’t close credit card accounts. If you wish to do so, call your credit card company representative to learn how to do so without affecting your score.
Any credit score drop you experience after paying off an installment loan will be temporary.
Make sure you keep a credit utilization ratio of less than 30%.
No good deed goes unpunished. But if you’re financially responsible most credit score drops will incrementally increase over time.