Your credit score can affect more aspects of your financial life than many people realize. From insurance costs to the cost of credit to job opportunities, your credit score can play a large role.
When your credit score drops, the cause could be one of several reasons — or there may be more than one reason.
Why did your credit score drop after paying off debt?
One of the more frustrating situations is when your credit score drops after paying off debt. It seems counterintuitive for your score to go down. After all, you were responsible and paid off the debt.
To understand why your score might drop after paying off a loan, it’s helpful to know how some of the factors that affect your credit score.
In this situation, where you just paid off debt, three main factors could be affecting your score: credit utilization ratio and age of accounts.
Credit utilization ratio
The ratio of debt to the amount of credit you’ve been extended is called credit utilization, which is measured as a percentage.Sometimes this is also referred to as a debt-to-credit ratio. High credit utilization can be a red flag and has a negative effect on your credit score.
For example, if you have two credit cards that total $5,000 in credit and you have $4,000 in balances, your credit utilization is 80%. A lower number, like 30% or less, is generally considered to be ideal. Many credit experts recommend keeping the percentage below 20% or even below 10% if possible.
To look at those same two credit card accounts, if you paid off the balance with a low credit utilization and then closed the account, the balance remaining on the remaining account would result in an increase in your overall credit utilization.
Age of accounts
In most cases, the age of accounts is probably the largest factor if your credit score drops after paying off debt. Credit bureaus calculate the average age of your credit when calculating your credit score.
Older accounts are good for your score, while newer accounts tend to drop your score. If you paid off an older account and then closed the account, the average age of your credit accounts may have gone down, dragging your credit score down as well.
Types of credit
It’s also possible for credit scores to be impacted by paying off a car loan or student loan. The types of credit you have play a role in your credit score, with a broader mix of credit types helping your score.
If you pay off an installment loan and now only have credit cards on which to base your credit score, your score could suffer. The types of credit you have can account for up to 10% of your overall credit score.
Why did your credit score drop after getting a new credit card?
There are different types of credit inquiries.
- A soft inquiry just requests credit history, such as when you check your own credit or when a lender checks your credit to send a preapproved offer or when an insurer checks your credit to help determine your premium or your insurability. Soft pulls or soft inquiries don’t hurt your credit score.
- A hard pull, however, is a request for new credit and hard inquiries can impact your credit score, dropping your score temporarily. Getting a new credit card is a hard pull on your credit and can cause your credit score the drop.
The average age of your credit card accounts is also adversely affected by a new credit card. If you closed an old credit card account at the same time that you opened the new card, the effect on the average age of your credit can be even larger.
Lower overall credit utilization can help to counteract the effects of the hard pull and reduced average age of credit — but this is more likely with low or average credit scores.
Those with higher scores may already be earning the highest possible score for credit utilization, so there’s no more benefit to be gained by lower credit utilization and only the hard pull and the lower average account age have an effect.
Why did your credit score go down after an increased utilization ratio?
Your credit utilization, which measures how much debt you have relative to your credit line, can account for up to 30% of your credit score, making this element of your score the second most important factor in your score following previous payment history, which accounts for up to 35% of your score.
For example, if you have one credit card with a $5,000 limit and you have a $3,000 balance, your credit utilization ratio is at 60% and your credit score may be lower as a result. If the balance is $4,500, the credit utilization jumps to 90%.
In many regards, a credit score is a reflection of risk — both for the lender and for the borrower. High balances relative to assigned credit lines can be a sign of potential trouble, which is why credit utilization plays such a large role in your overall credit score.
Paying down the balance to below 30%, in most cases, will help your score — although there are several moving parts in a credit score so it’s possible the gain in one area, like credit utilization, may be offset by less favorable data in another area, like the average age of credit or requests for new credit.
Why did your credit score drop for no visible reason?
If you’ve made no new purchases on credit, made all your payments on time, and haven’t applied for new credit — but your credit score dropped, it’s possible that you may be a victim of identity theft.
Before you freeze all your cards or cancel accounts, get a copy of your credit report. You can purchase your report online from a credit bureau like Experian, which can provide 3-bureau reports online.
You can also get a copy of your credit reports from the three main credit bureaus by visiting AnnualCreditReport.com, which is free but credit report access is limited to once per year.
Look for anything unusual, like unfamiliar accounts or charges. From merchants to banks to healthcare providers to the credit bureaus themselves, the risk of data breaches is real and millions of people have had their credit or personal information compromised, often without ever knowing about the breach.
The damage, in the form of identity theft, can come weeks or months or even years later. Depending on the type of information that has been compromised, there are actions you can take to reduce the damage or reverse the charges.
IndentityTheft.gov has a useful guide of options if you become the victim of identity theft.
Other reasons that can cause your credit score to drop
Your credit score isn’t a static number. It changes over time and based on your ongoing credit activity. Think of your score as a snapshot of your overall credit performance at a given point in time.
Here are some additional factors that can affect your score:
- Co-signed a loan: Many people think a co-signed loan can only hurt your score if there are late payments but it can also affect your credit utilization ratio, the number of credit accounts, and of course, a co-signed loan starts with a hard pull on your credit. Expect your score to drop a bit if you co-sign a loan for someone.
- Bankruptcy: Bankruptcies can stay on your credit report for up to 10 years, pulling down your score.
- Closed a credit card: Closing an old credit card account can impact your average age of credit. Also, closing any credit card — old or new — can affect your credit utilization score because after closing the card, you have less available credit relative to your remaining credit card balances.
- Applied for new credit: Applying for new credit always results in a hard pull of your credit report and can reduce your overall credit score. Similar types of inquiries within a short time period may be counted as one inquiry for scoring purposes, however, like when you’re shopping for a car loan or a mortgage.
- An unpaid account sent to collections: When a creditor sells an unpaid debt to a collection agency, a new account appears on your credit report. A collection item on your credit report can affect your score for 7 years or longer.
- Late credit card payment: Your payment history can account for up to 35% of your credit score. A single late payment can cause a large drop in your score.
- Mistakes in your credit report: Mistakes can happen in any business, and credit bureaus and creditors are no exception. Contact the credit bureau that shows the error to dispute the incorrect information.
Tips for improving and monitoring your credit score
Your credit score can change from month to month and by building good credit habits, you should see your score improve over time.
Here are some of the steps you can take to improve your overall credit score.
- Be aware of credit utilization ratios: At up to 30% of your overall credit score, the amount of debt you carry compared to your credit lines can have a large effect on your score. Try to keep credit utilization on revolving accounts (credit cards) below 30%.
- Maintain on-time payments: Up to 35% of your overall credit score reflects your payment history. Newer missed payments can hurt your score the most, particularly if you had good credit before the missed payment. Prioritize making credit payments on time.
- Avoid new credit: Apply for new credit will cause your score to drop. Consider your needs carefully before applying for new credit.
- Don’t cancel old credit cards: The average age of your credit accounts plays a role in your overall credit score. Consider storing old credit cards that you aren’t using in a safe place rather than canceling the card. Also, be sure to remove old cards from online merchant accounts so they can’t be used inadvertently.
- Get a free annual report or utilize a credit monitoring service: You can get your credit reports for free once per year at AnnualCreditReport.com. Alternatively, a number of online services offer free credit reports or paid credit monitoring with alerts. As with any financial service products, invest some time in research on the company and its fees before choosing a service.
If your credit score drops take the right steps to fix the problem
If your credit score drops, often there’s no reason to panic if you’re still handling credit responsibly. Credit scores don’t always move in a straight line up or down.
Expect some fluctuation in your credit score but also an overall trendline that tells the story of how your credit reports reflect your credit behavior.
If your credit score drops, find out why. The effects are only temporary if you take the right steps to fix the problem.