Can paying off debt too quickly LOWER my credit score?

39 views

My girlfriend, who is more knowledgable about finance than myself, claims this is true. This seems counterintuitive to me and I need some more insight.

In: 5

Credit score is determined by how responsible you are with your debts, but not sensible to how fast you pay them. So paying on time for a period of time is usually more positive than paying it all asap

[removed]

It depends on the nature of the debt.

If it is a credit card, you can pay the balance off daily and it will still have a net positive effect on your score as long as the credit card itself remains open (which it will, if you use it at least once a year or so). This will keep your reported credit utilization low (good), keeps a history of on-time payments (good), and gradually increases the average age of your credit lines (good).

If we’re talking about a loan like for a car or for a mortgage, then paying it off early *does* hurt your score, because the account is closed out once you pay it off.

It is not going to outright *tank* your credit score as long as you otherwise have positive factors and a good credit history, but it *is* something to be mindful of when planning out future loans. For instance, if you’re planning on opening a mortgage to buy a house in a couple months, and you have an auto loan that has eight months of payments left but you can pay it off *today*… well, it could actually be better to just keep making the regular payments on that auto loan so you don’t drop your credit score before opening the mortgage.

But, if you don’t feel like you’re going to need any new loans for the next several months and you have other steady ways of building and maintaining credit (like having a few credit cards open at once that you are using responsibly), then paying off the car loan today would drop your score, but you’d probably rebuild it before the year closed out anyway.

And as Experian writes – https://www.experian.com/blogs/ask-experian/why-did-my-credit-score-drop-when-I-paid-off-a-loan/ – the negative effect varies depending on a *lot* of different factors, and in some cases a person might not experience any score drop or their score might even go up a little. But, imo, because of the possibility that it *does* go down, it’s good to plan around, especially for situations like I mentioned.

There are some situations where because paying off a loan and closing the account can end up reducing the average age of one’s lines of credit, a small net negative in some credit score models could be observed.

Reducing the number and average age of accounts might reduce your score a tiny bit, but in general, doing the right thing with regard to debt will result in a high score. Don’t worry about gaming the system and such, just pay your debts on time, take on various types of credit (but responsibly) and you’ll end up with a good credit score.

Your credit score is essentially the amount you can borrow at any given time. It combines all your credit lines/debt. So if you had say a 20k loan you could afford to pay off in one shot, that would know 20k off your credit line. So its usually a good idea to replace it with a new line if credit, so the total you can borrow doesn’t drop.