Why Credit Scores Could Drop After Paying Off Credit Cards

Updated: March 16, 2024 Author:

    Understanding the Paradox: Lower Credit Score After Paying off Debt

    Logically, you’d think that clearing debts would have a positive impact on your credit report. You’d expect it to increase. The opposite can happen though, and for several reasons. Your credit report is made up of various sections. Payment history, age of credit accounts, types of credit, and credit utilisation for each of your revolving credit accounts. When you pay off debts, of any type, (not just credit cards), it alters your credit profile. Sometimes, for the better, other times, like when your score dips, it’s for the worse. Depending on how you paid it off – with a balance transfer card or a debt consolidation loan, it may have altered the credit mix on your credit files. 

    6 Reasons for Credit Scores Dropping After Clearing Debts

    1. Was It Done with a Debt Consolidation Loan? 

    Technically, a debt consolidation loan is not clearing the debt. It’s shifting it. It is common when you have multiple credit cards, secured loans, and car finance to roll everything into a debt consolidation loan, pay off credit cards and other credit agreements, and possibly save in interest fees in the process. The downside is that the initial application for a secured loan dents your credit score. It will be short-lived and your score will improve once your credit files are updated with several on-time payments toward the installment loan. The other thing that happens when you pay off multiple types of debts is that you lower the mix of credit types you have. 

    2. A Change to Your Credit Mix

    Part of how UK credit scoring works is by assessing your track record in managing different types of credit. Lenders like to see a diverse credit profile of both installment loans (car finance and mortgages) as well as revolving credit. When you pay off your credit card, there’s less of a credit mix. More so if you close the account. Also, if you were to have used a balance transfer credit card, getting the new credit card can lower your credit score temporarily due to the hard search on your credit files. 

    3. Closing Accounts Dings Your Credit Utilisation 

    Your credit utilisation is the total amount of credit you have available across all revolving credit accounts. If you close any of those accounts (like credit cards, and store credit accounts), the maximum available credit will decrease, possibly substantially. You could have a couple of store accounts with a £1,000 limit each, and three credit cards with a combined max credit limit of £15,000, as an example. If you were to close two credit card accounts and keep the one with the better interest rate, you may be dropping your overall credit limits by thousands. It is better to have more credit available and unused than it is to use most of what credit is available. The ideal range is to keep credit accounts below 25% of the credit limit so as not to appear to be overstretched. An overdraft affects your credit score the same as credit cards. Aim to keep balances on all credit accounts below 25% of the credit limit. 

    4. Less Repayment History Being Reported

    When you pay off your credit cards, no more payments are being recorded on that account. If you did use a loan or another credit card for a balance transfer, that will be a new account with a lack of payment history. A significant percentage of your credit score is weighted by your payment history. New credit accounts lack this, and if, for example, several months have passed with no records being updated to your credit files, it’s likely to signal a change in spending habits. Credit scores factor for stability so any changes to your spending habits can have a slight, albeit temporary, impact on your credit score. 

    5. Shortened Length of Established Credit History

    This only applies if you closed your credit card account after paying it off. Part of your credit score is tied to the age of your accounts. Even if you used a balance transfer card to take advantage of an interest-free period, you do not need to close the account. You can shift the balance to a new card, and keep your old account active. If you close your account after doing a balance transfer, you’d lose the credit limit, instantly raising your credit utilisation, and also having the new balance reported on a new account. Lenders like to see a succession of timely repayments rather than a new account with only two or three months of payment history. 

    6. Timing of Reporting

    Most credit card providers update Credit Reference Agencies monthly. Depending on the date you paid off the card(s) and the date the lender reports updates on your account, there can be an overlap. Whilst most update monthly, to account for the overlap of when you pay to when they update your credit files, allow up to 60 days, or two billing cycles. When you check your credit report, look at the credit balances section to see if the debts are reporting as cleared, or if it’s still showing the balance as outstanding. If it’s yet to be updated, wait a month for the information to be updated. 

    Other Factors that Contribute to Lowering Credit Scores

    Credit card balances are only one section of credit reports. It is possible that something else entirely has been added as an entry that’s causing the score to be lowered. For example, if a financial association is created with a partner with bad credit, such as opening a joint savings account after paying off credit cards, that could be the reason for the lower credit score. For the most part, credit scores lower when any of the weighting factors change on your credit report. Other than those above, check your credit reports for accuracy and remember to allow time for your repayments to be reported.