Why did my credit score drop when I paid off a loan?
Someone finally pays a car loan or even a mortgage and how is it rewarded? Seeing a drop of 10 to 50 points in their credit score.
Perhaps you have even been in this situation yourself.
So what caused your credit score to drop when you paid off that loan?
Why paying off a loan can actually hurt your credit score
In order to understand why your credit score can drop when you pay off a loan, it is important to know how credit scores are calculated. Here is an overview:
These percentages tell you how important each of these factors is in determining your overall credit score:
- Payment history: 35%
- Amounts due: 30%
- Length of credit history: 15%
- New credit: 10%
- Credit mix: 10%
This is the 10% credit mix that you want to pay attention to here. This is the one that explains why your credit score can suffer when you pay off a loan.
“Scoring models pretty much universally want to see so many different types of credit to get the best idea of who you are with credit,” says financial expert Clark Howard.
According to CreditCards.com, this mixture could include:
- Installment loans, including car loans, student loans and the purchase of furniture
- Bank credit cards
- Retail credit cards
- Gas station credit cards
- Unpaid loans contracted by collection agencies or debt buyers
- Rental data
While 10% might not seem like a lot, it’s enough that your score can drop from 10 to around 50 points if you pay off a loan, depending on how many other types of credit you have and how much you have. amount. re using.
Still, you shouldn’t feel the urge to take on new types of debt just to boost your score.
“People who only use revolving credit like credit cards are going to find that over time, not having a mortgage, not having a car loan, will start to pinch your score,” says Clark. “But even if you only have credit cards – which is all I’ve had for a very, very long time – I’m still able to maintain a score in the 820s. You can have a great credit score. while maintaining the narrow forms of credit on which your rating is based. “
Clark thinks it’s unfair that people are “punished” by a drop in their credit score when paying off a loan shows you’re really responsible for the credit, but he really wants you to brush it off and watch. the big picture.
“Don’t get obsessed with credit score unless you’re trying to buy something and you’re in the score bubble,” he says. “If your credit score is in the top 700 or higher, you can get the most preferential interest rate on anything you want.”