Does Paying Down Debt Increase Your Credit Score?

If you have debt, such as credit card debt, auto loan, home mortgage, can paying down your debts increase your credit score? We will explore whether paying off your debts can increase your credit score?

Does Paying Down Debt Increase Your Credit Score?

Paying down debt can increase your credit score, but it really depends on the type of debt you’re paying off. Paying off installment accounts, such as personal loans, auto loans, or mortgages can result in a small and temporary drop in your credit score while paying down credit card debt can result in a quick increase in your credit score because it decreases your credit utilization.

Paying down debt such as your credit card balance can raise your credit score because your credit utilization makes up 30% of your credit score. The lower your credit utilization, the better your credit score will be. When you pay down your credit card balance, you’re decreasing your credit utilization, therefore raising your credit score.

On the other hand, when you pay off something such as a car loan, mortgage, or personal loan, you might notice a slight and temporary drop in your credit score. This drop occurs because when you pay down such debts, you’re essentially closing an installment account.

When you close an installment account, you’re reducing the diversity of your accounts, which can result in a small and temporary drop in your credit score.

That said, if you close an installment account, your credit score should recover within a short few months so long as you continue to make payments on all of your other credit cards and accounts.

Which Debt Should You Pay Off First To Increase Your Credit Score?

The quickest way to increase your credit score is to begin with paying off credit card debt. Paying off credit card debt will allow you to see a quick increase in your credit score. This is especially true if you’re utilizing a lot of your available credit.

Paying off credit card debt can increase your credit score significantly because your credit utilization makes up 30% of your credit score. Whenever you pay down your credit card debt, you’re increasing your available credit, which can boost your credit score. So, for quick results, start off with paying down your credit card balances.

For example, if you have a total credit limit of $10,000 and you pay down your credit card balances from $5,000 to $2,000, you’re decreasing your credit utilization from 50% to 20%, which can dramatically boost your credit score.

This is so because the lower your credit utilization, the better your credit score will be.

As a rule of thumb, you should strive to keep your credit utilization below 10% and never exceed 30%. If you exceed 30% credit utilization, your credit score will drop significantly. So, start by paying down your credit card debt.

After you’ve paid off your credit cards, it’s time to turn your attention to installment accounts, such as home loans, auto loans, student loans, and other types of debt with a fixed monthly payment.

Paying down the debt on such accounts will improve your credit but not to the extent that paying down your credit cards would.

Paying down credit card debt is much more important and will have a bigger positive impact on your credit score than paying down installment accounts because they affect your credit utilization ratio, which makes up 30% of your credit score.

So, when deciding which debt to begin paying off first, begin with credit card debt.

When choosing which credit card to start with, you have a few options to choose from:

  1. Paying down the credit card with the highest interest rate – You should consider paying down the balance on the credit card with the highest interest rate because debt is often the most costly you may have. So, paying it off first can save you a significant amount of money.

  2. Paying down the credit card with the highest credit utilization – A second option that you have is beginning to pay down the credit card with the highest credit utilization rate. Going with this strategy is the quickest way to raise your credit score because credit utilization makes up 30% of your credit score. So, paying down the balance on a credit card with a high credit utilization can be a great way to improve your credit score.

  3. Paying down the credit card with the lowest balance – A third option that you have is paying down the credit card with the lowest balance. Some people prefer this method because it can reduce the number of accounts you have to keep track of. This method could also improve your credit score, especially if you manage to pay down the balance to $0.

Regardless of which method you choose, stick to paying down your debt, and if you manage to pay off a significant amount of credit card, you will notice a boost in your credit score.

Why Does Paying Off An Installment Account Often Result In a Credit Score Drop?

When you pay off an installment loan, you’d expect an increase in your credit score. Sadly, most of the time, when paying off an installment account such as a personal loan, car loan, student loan, home mortgage, or other debt where you have a fixed payment every month, you will notice a drop in your credit score.

The amount of points your score will drop differs from one person to another, but a small drop is to be expected whenever you close an installment account. Experts believe that this drop occurs because paying off a personal loan, car loan, home loan, or any other type of loan essentially involves closing an installment account.

Whenever you close an installment account, you’re reducing the diversity of your open accounts, which affects your credit mix. Your credit mix accounts for 10% of your credit score. For this reason, your score may drop by a few points.

That said, such a drop is likely going to be temporary and your credit score should rebound within a few months of continuing to make all of your credit card and loan payments on time.

1. Does paying down credit card debt increase your credit score?

Yes, paying down credit card debt can increase your credit score because it reduces your credit utilization (how much of your available credit you’re using), which can boost your credit score. Your credit utilization makes up 30% of your credit score and rewards you when you lower the balances on credit cards. So, yes pay down your credit cards and you should see a boost in your credit score.

2. Does paying off my car increase my credit score?

Paying off your car is unlikely to increase your credit score. In fact, when paying off your car, you’re essentially closing an installment account, which usually results in a temporary drop in your credit score. That said, your credit score should recover within a few months so long as you made all of the payments on your car loan.

3. Why did my credit score drop after paying off debt?

Typically, paying down credit card debt results in a credit score increase, especially if you were carrying a lot of credit card debt. This is so because paying down your credit card will likely decrease your credit utilization rate, increasing your credit score.

4. How fast does your credit score go up after paying off credit card debt?

Your credit score may go up within 30 to 60 days after paying off a credit card. This is so because it takes some time for your credit card issuer to report the new account status to the credit reporting bureaus.