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Punch Associates Discusses The Reasons Why Paying Off Debt Can Negatively Impact Your Credit Score

Paying Off Debt Can Negatively Impact Your Credit Score

Improving your credit score seems like it should be a straightforward endeavor. You utilize your credit properly, pay what you must on time, check to see that everything’s accurate, and eventually, you’ll be rewarded with a credit score that is agreeable to any lender.

In many ways, raising your credit score is simple enough, but there are also those instances where you may get confused by what just happened.

Here’s an example scenario: You just paid off this loan that you’ve had for a long time and you think that your credit score will be better for it. But then, you look at your credit report the following month and notice that your score has actually gone down.

So, what gives there?

As financial experts such as Punch Associates are always quick to point, the mechanics of credit scores are not always intuitive. Paying off debt is not always going to be good for your credit score and the reasons why that can be the case are included below.

Your Credit Utilization Ratio Changes

According to Investopedia, your credit utilization ratio or the amount of money you owe has a significant impact on your credit score. It even accounts for 30 percent of your score.

Now think of what happens when you finally pay off a previous loan and subsequently close that account. Suddenly, your credit utilization ratio has changed. You could very well have no more money owed.

Not owing any money is obviously not a bad thing, but it can impact your credit score because demonstrating that the ability to make payments on time is something that lenders look fondly upon. In a way, owing a little bit of money can actually be better for your score than owing nothing.

Aside from that, it can also be a problem if the account that you paid off was the only one with a low balance remaining. With only high-balance accounts associated with your name, your credit utilization ratio may start to look worse.

The Payment History Linked to the Account Is Affecting Your Credit Score

It was noted above that your credit utilization ratio accounts for 30 percent of your credit score. That is not the biggest determining factor of your credit score, however. The only one that exceeds that is your payment history, which accounts for 35 percent of the score you are given.

You’re not going to encounter any issues if the account you paid off had a good payment history attached to it. If anything, the payment history linked to that account may even continue to have a positive effect on your credit score for months and years to come.

The issue is if you paid off and closed an account with poor payment history. You may assume that the bad history connected to that account will no longer be a problem, but that’s not what happens.

According to Experian, the payments you were late will continue to show up in your credit score for up to seven years. That is part of the reason why financial experts like Punch Associates always remind clients to be as diligent as possible with their payments.

The only saving grace for you here, if you did have an account with bad payment history, is that its impact on your credit score will lessen over time. The missed payments may stay on your report for seven years, but they could become less significant well before then.

You Closed an Older Account

The history associated with a specific account is not the only thing you should be mindful of if you don’t want your credit score to drop after making a payment. The age of the account matters as well. To be more specific, the length of your credit history accounts for 15 percent of your score.

It is worth reiterating here that you should absolutely pay off your debt on time. Don’t put off doing so because you’re afraid of the impact it could have on your credit.

There are just certain scenarios where the final payment you make towards your oldest loan means that it will close down and that is going to affect the next score you’re getting. You can’t do anything about that.

However, if the payments you’re making are for a credit card, you don’t have to close that account down just because you’ve paid it off completely. You can opt to leave the credit card account open and have it continually raise your score.

The Payment Caused an Error to Be Made

Of all the reasons why your credit score may be adversely affected by you paying off a loan or credit card debt, this is the one that is most frustrating.

Unfortunately, no one is immune from error. During the process of closing your recently paid account, a mistake may have been made causing inaccuracies to show up on your credit report.

You should always be vigilant with regards to your credit. Take advantage of those free credit reports you can request from the three major agencies – Equifax, Experian, and TransUnion – and make sure that they are as accurate as they can be.

If you find an error, report it to the corresponding agency to get it fixed and help your credit score.

The idea that paying off debt can hurt your credit score may seem absurd at first, but as the reasons above illustrate, it actually makes sense. For those who need more advice regarding their credit and their debt, financial experts such as Punch Associates can lend a helping hand.

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