Why Your Credit Score May Drop After You Pay Off Your Personal Loan

Paying off a loan can feel like a burden on your shoulders, especially if you are uncomfortable with being in debt. But there are other benefits of focusing on paying off debt, such as improving your debt-to-income ratio and improving your credit rating.

As a general rule, paying off revolving debt like credit card balances can help improve your credit score, assuming no further payments have been made late and you don’t take out multiple new lines. credit at the same time.

But when it comes to installment debt like personal loans, you might not notice any change in your credit score after you pay off the balance. In fact, in some cases you may even see your score drop slightly as a result. It may seem confusing and daunting at the same time, but there are several reasons why you may not see an increase in your credit score after paying off a personal loan.

Just keep in mind that such a drop in your credit score is temporary and you should never avoid paying off your debts because of it; Your credit score can always be recovered over time by pursuing positive credit management habits, such as keeping a low rate of credit usage and never missing a payment.

The the length of your credit history is 15% of your FICO score. It is calculated by looking at the age of each of your open credit accounts and finding the average of them. Generally, the longer your credit history, the higher your credit score tends to be.

If your personal loan is one of your oldest permanent accounts, once repaid, it is closed and will no longer be taken into account when determining the average age of your account. Because of this, your credit history may appear to be going down. However, over time, the average age of your account and the length of your credit history may increase since you will have been a consumer of credit with other forms of credit open for even longer.

Another important factor in determining your credit score is credit mix. Credit makeup is only 10% of your FICO score, but it’s still an important part of determining your creditworthiness. Credit bureaus want to make sure that you have an effective history of handling different types of credit, including credit cards, auto loans, mortgages, and any other form of credit.

A credit card is a widely used form of credit, but having a personal loan account open can also contribute to a more diverse credit mix, as credit cards are a form of revolving credit and personal loans. are a form of installment credit.

With revolving credit, you get a limit and can repeatedly borrow as much money as you need up to that limit as long as you pay back what you borrow. But with installment credit, you have a set time to pay off the full amount you borrowed, and it’s usually paid back in fixed monthly increments. Different lenders have different repayment periods (i.e. loan terms) – Upstart personal loans, for example, have loan terms starting at 36 months, while OneMain Financial personal loans have terms as short as 24 months.

So if your personal loan was the only non-credit card account you had and you paid it off and closed, you would end up with a much less diverse credit mix, which could explain a drop in your credit score. .

Of course, you may also wonder if your personal loan repayment and your credit rating drop may have coincided with you. apply for a new credit card, take out a car loan, or even increase your spending on an existing credit card. These are all actions that can temporarily lower your credit score, as applying for a new line of credit opens up a serious investigation into your credit report, and increasing your credit card spending means increasing your rate of credit usage. credit.

Credit usage is a measure of how much credit you use versus how much credit you have. Typically, a high usage rate indicates that you are using too much credit. Experts therefore generally recommend keeping this rate below 30% to maintain a good reputation.

Paying off a personal loan can affect your credit score, but ultimately the magnitude of the impact depends on your credit profile, including how long you’ve been open for credit accounts. , the diversity of your credit mix and the other forms of credit you have applied for.

While it can be disheartening to see a slight drop in your credit score after paying off a personal loan, remember that the drop will only be temporary – over time, continue to make payments on time on your loans. other accounts and watch your credit. use can help you increase your credit score.

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