Why does credit score drop after paying off a loan?
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Your credit score is based on a few things, but let’s talk about the three main ones. First, there’s capacity, which is how much you’re borrowing compared to how much you can borrow. Credit cards are a big part of this. Then, there’s payment history, which is all about how well you’ve paid back loans in the past and how you’re doing now. Lastly, there’s credit mix, which looks at the different types of loans you have, like credit cards, car loans, and home loans. Having a mix can be better. Car loans and mortgages impact your credit more than credit cards. Personal loans also help your score more than credit cards, but not as much as car or home loans.
Scenario One – Let’s say you pay off your car loan, but you still have credit card debt and no home loan. Congrats on paying off your car! But now, you have one less positive payment showing up each month. The car loan helped your score a lot because it was a structured loan with collateral (the car). Losing that can make your score drop a bit. This is similar to what happens if you pay off a mortgage too.
Scenario Two – Now, let’s say you’re paying extra each month on your credit cards and lowering the balance. As you reduce your balance, you’re freeing up your credit limit, which is good. If you pay off your credit card, that’s great! You’ll have positive recent payment history and more available credit, which helps your score. Even with a zero balance, credit cards are still good for your credit report. It’s like “no news is good news.” If you pay off a credit card, leave it open unless it has a yearly fee you don’t want to pay.
There is no secret backdoor income calculations done for your credit score as a top answer said, that isn’t true.
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