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Why did my credit score drop when my balance decreased?

why did my credit score drop when my balance decreased

Your credit score may drop when your debt balance decreases when there are closures to accounts/ This can lower the diversity and age ranges of your credit accounts. Additionally, any negative actions like late payments that happen around the same time can also lower your credit scores. 

The reasons for this revolve around how credit reports function in relation to credit scoring models. Gaining a more thorough knowledge of how credit works will help you better understand why there can be fluctuations in your credit score throughout the journey to financial freedom. 

We will break down exactly what information is included in your credit report, how that translates into a three-digit credit score, and what might be the cause of temporary drops from credit utilization to the age of accounts. 

How Your Credit Report Works

Credit reports are central to people’s overall financial well-being. Credit reports are used in the approval of all new forms of credit but not only that. In addition to lenders, credit reports are often consulted by landlords, insurance companies, and even employers.

Three Credit Bureaus

There are three major credit bureaus in the United States that compile an individual credit report for each consumer—Experian, Equifax, and TransUnion. Every consumer has the legal right to request a free copy of their credit report from each credit bureau once every year. A survey conducted in 2020 shows that only 33% of Americans checked their credit reports in the past year.1

Your credit report includes information about your credit accounts, credit inquiries, public records, and collection accounts. It will also include personally-identifying details to connect you to your report for accessibility.  

Calculation of Credit Scores

There are several different credit scoring models available but by far, the most common ones are the FICO score and VantageScore. Both scoring models utilize five categories to calculate your individual three-digit score. 

Each category accounts for a different percentage of your score’s calculation. Here is the general formula most credit scores follow:

CategoryPercentage
Payment History35%
Amount Owed/Credit Utilization Rate30%
Length of Credit History15%
Credit Mix10%
New Credit10%

Below is more information on each category:

Payment History 

The payment history of all the credit accounts on your credit reports makes up 35% of your credit score calculation, making it the most considerable portion of your score. 

It is for this reason that so many financial experts strongly emphasize the importance of making your payments on time to maintain a positive payment history for good credit scores. Every late payment you make can stay on your credit report for up to seven years.

Amount Owed/Credit Utilization Rate

30% of your credit score is your overall credit usage, i.e., the total amounts owed in both revolving credit and loans. Your credit utilization ratio plays an important role in this category and can make a significant difference in your score as you are repaying debt. Most financial experts recommend a credit utilization of 30% or below. 

Length of Credit History 

The length of your credit history accounts for 15% of your credit scores and takes into consideration the age of your oldest credit account, the age of your newest account, and the overall average account age. A credit history that has been established for a longer period of time will give a consumer better credit scores. 

Closing credit card accounts should not affect this portion of your score too much unless it was an account you closed years ago. Closed credit card accounts remain on your credit report for up to 10 years. 

Credit Mix 

The variety of credit that you have is 10% of your credit scores. The idea behind this category in the calculation is to encourage a more diverse credit mix so consumers don’t have only one type of credit account. Account types can include personal loan options, cash advance loans, credit cards, auto loans, mortgage loans, etc. 

New Credit 

Whenever you fill out an application for a new loan or credit card, you are authorizing that credit card issuer or lender to pull a copy of your credit report. Each time this happens, a new hard inquiry will appear on your credit report. Too many hard inquiries on your credit report within a short period of time can harm your credit. 

Reasons Why You Might See Your Credit Score Drop 

Even if you are doing everything right to improve your financial situation, you might still see a drop in your credit score. This might be frustrating, but if it happened because of a decrease in your credit card balance, you are likely to see it even out soon. 

There are several reasons why you might see changes in your credit score while paying off your debts. While most of these reasons are minor and short-lived, knowing what they are will help you keep an eye out for them and possibly allow you to avoid too much damage or rebuild your credit more quickly. 

Changes in Credit Utilization Rate

Any major shift in your credit utilization ratio will result in some significant changes in your credit score. It’s ideal to have a higher credit limit and lower used credit, so if your total limit suddenly decreases after the closing of a credit card account, your credit utilization rate will likely increase. And a higher credit utilization will bring down your credit score. While the closed credit card account will remain in your credit history, its credit limit will not be included in your total available credit.

Lack of Diversity in Your Credit Mix

If you are paying off a variety of debts, you could experience a temporary drop in your credit score from a change in your credit mix. Paying off a car loan is an incredible accomplishment, but it will decrease the variety of accounts you have active on your report. Your credit score could go down if you only have one type of debt left on your report.

Average Age of Credit Accounts

If you closed some accounts a while back, you might see a change in your credit score, especially if it was one of your oldest accounts. Your average account age as well as the age of your oldest account, is crucial to calculating how well-established your credit history is. A large shift in the age of your credit history would lead to a drop in your credit score that could require some effort of credit rebuilding to rectify. 

Tips for Avoiding a Credit Score Drop When Paying Off Debt

Thankfully, there are some actions you can take to minimize damage to your credit score while paying off your debt. And there are a myriad of ways to rebuild your credit after an unexpected blow to your score. Here are some suggestions for how to keep your credit in good shape before or after a drop in your score:

Keep Credit Accounts Open

Once you have paid off a credit card’s balance, avoid closing the account immediately. While it might feel good to close a credit card for the finality of it, keeping the account open could protect your credit utilization ratio. Consider leaving the account open and not using the card. 

If the credit card issuer requires that you carry a balance, you could simply use the card for an auto-payment on an inexpensive bill such as your Netflix subscription. You can pay off the charge each month, allowing you to keep the card open without using it regularly. 

Use Credit Sparingly and Responsibly

As you move forward after minimizing your debt, it is important to still practice responsible credit usage. Use any remaining credit cards you have open sparingly so you don’t end up in a situation where you have an overwhelming amount of debt. 

Stop Applying For New Credit

To give time for your credit to recover, take a break from applying for any new credit products. Put your focus towards paying off debt such as current loan balances and credit card debt rather than applying for or opening any new ones.

Check Your Credit Report Often

According to the Federal Trade Commission (FTC), one in five people will have a credit error on their credit report.2 Checking your credit reports regularly can help you catch any mistakes on your report before they have a chance to harm your credit score. If you ever see any errors or inaccuracies on your credit report, you can dispute them right away to the credit bureaus so they can be rectified. 

Consider Paying Off Debt In Full 

If you are able, we recommend paying off the total balance on your loans and credit cards. Not only will this allow you to save a significant amount of money on interest but it will also keep your credit usage as low as possible. 

FAQS: Credit Scores Drop After Paying off Debt

How do missed payments impact credit scores compared to high credit usage?

Missed payments can have a significant negative impact on credit scores, often more than high credit usage. This is because, as mentioned above, payment history is the most significant factor that impacts credit. It’s essential to prioritize on-time debt payments to maintain a healthy score.

If I request an increase in my credit limit on a revolving account, will it affect my credit score?

Requesting a credit limit increase might result in a temporary “hard inquiry” on your credit report, which can cause a slight drop in credit scores. However, if approved, a higher credit limit can reduce your credit usage ratio, potentially benefiting your score in the long run.

How does the average age of my credit accounts influence my credit scores?

The average age of your credit accounts is a factor in credit scoring. Older accounts can lead to a good credit score as they demonstrate a longer history of credit management. Opening new accounts can reduce this average age, potentially causing a temporary drop in credit scores.

What’s the difference between available credit and credit limit?

Your credit limit is the maximum amount you can borrow, while available credit is the difference between your credit limit and your current balance. Maintaining a higher amount of available credit can positively influence your credit scores. Credit card issuers are the main institutions you’ll have to deal with when asking about available credit and credit limits.

Is paying off an installment loan early beneficial for my credit scores?

Paying off a loan early can reduce your overall debt, but it might also decrease your credit diversity, which is a factor in credit scores. While it can lead to a temporary drop, in the long term, reducing debt is generally beneficial for financial health.

How can I stabilize a fluctuating credit score?

Fluctuating credit scores can result from various factors, including changes in credit usage, recent inquiries, or updates to your credit report. Regularly monitoring your credit, ensuring on-time payments, and maintaining a low credit utilization ratio can help stabilize your score.

Does the type of debt payments (credit cards vs. installment loans) influence how they affect my credit scores?

Yes, credit cards are revolving, meaning their balances can be carried from month to month, while installment loans have fixed monthly payments. Credit scores often weigh credit card balances more heavily, so reducing this type of debt can have a more immediate positive effect on your score.

Key Takeaways With CreditNinja

Your credit score can drop for several reasons, one of which may happen after a balance decrease. Usually, the balance decrease itself will not bring down your score, but there may be other actions, such as late payments, that happen to be around the same time of paying off debt. 

Regardless, it’s important to keep track of your credit reports to ensure you stay informed. It’s also imperative to learn about the different actions that can harm or improve your credit. To learn more about credit scores, reports, and finances in general, check out CreditNinja’s blogs!

References:

  1. 15+ Credit Score Statistics for 2023 | Finnmasters
  2.  How Common are Credit Report Error | Mccarthy Law
  3. Why Credit Scores Could Drop After Paying Off Credit Cards | Experian
  4. Why Did My Credit Score Drop? | Capital One

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