Say you have a credit card you use for all of your expenses. You pay it off in full each month and find that it’s a great way to earn points. The only problem: You’ve paid off your debt and the credit score has decreased.
You might be wondering, “Why did my credit score drop after paying off the debt?” There are a ton of variables that contribute to your credit score. Some of these elements are more obvious than others such as your credit utilization rate (the percentage of available credit you use each month).
Paid off debt and credit score decreased
It doesn’t seem right, does it?
Well, not unless you take the aforementioned credit utilization rate into account. Remember our scenario from earlier? Let’s say that you use your credit card for everything and your available credit is $7,000. Because you’re using this card for everything (and you’re paying it in full each month), you end up paying back $2,000 to $3,500. In that situation, you’re utilization rate is 28.5 to 50 percent.
This utilization rate falls under one of the biggest contributing factors to your FICO score: amount owed. This rate is calculated for each credit card and for all of them combined. The lower your utilization rate for each card and combined, the better for your credit score.
In fact, a FICO study found that consumers with the highest credit scores (above 785) used, on average, only 7 percent of their available credit on credit cards. That means they charge only $350 on a credit card with a $5,000 credit limit. Or, just $1,400 on several credit cards with combined limits of $20,000.
While paying off your credit card debt is important, what matters more is on-time payments and utilization rate. Many times, borrowers will ignore these factors, thinking that clearing up their debt as quickly as possible is the key to a stellar score.
Here’s something to remember: Paying off your entire balance every month is not reflected in your utilization rate or, ultimately, your credit score. The balance that is used to calculate your utilization rate is based on your last statement balance. So, you could charge $900 on a credit card with a $1,000 limit and pay it off the same month, but the FICO credit score will still consider a utilization rate of 90 percent.
When you’ve paid off your debt and the credit score has decreased, look to just how much of your credit you are using. If it’s above 30 percent, you might consider charging less each month. If that isn’t an option, you could speak with your issuer about increasing your credit limit.
You also could open another credit card to increase your total available credit and spread your charging among several cards, but your credit will initially take a hit when applying for the credit card. That ding will lessen over time and disappear altogether after two years.
Take a close look at your spending habits
When you’ve paid off your debt and the credit score has decreased, it can seem like a mistake. Chances are high that it’s not and if you’ve found yourself in this situation, you should consider all the possibilities. Chief among them is the cardholder’s utilization rate or inconsistent payment history.
Instead of asking why your credit score dropped after paying off the debt, examine your spending habits. This can give a better insight into why your score is trending the way it has been.