Does paying off debt improve your credit score?

You'll have a credit score if you’ve opened a credit card or taken out student loans. It’s a number typically ranging from 0 to 1000 and signals a consumer’s creditworthiness. Your score is determined by various factors, including whether you pay off debt, your payment history, and the types of loans you take out. 

Unfortunately, bad credit follows you, affecting your ability to get a home loan, your loan rates, and the types of credit you can take out. Improving your credit score is, therefore, vital to the future of your personal finance. 

Let’s get to the following commonly asked questions:

• How much will my credit score increase if I pay off debt?
• Does paying the debt in total help your credit score?
• Why did my credit score drop 40 points after paying off debt?
• How do you get an 800 credit score?

Related: What is the average credit card debt in Australia?

How much will my credit score increase if I pay off debt?

Generally speaking, paying off debt will improve your credit in the long run. However, the impact on your credit will vary depending on your credit utilisation ratio, i.e. the amount of revolving debts you have divided by the amount of revolving credit available to you. If you’ve reached your credit limit and paid your total balance, your score could climb by as much as 10 points. However, if you’ve used under 30 per cent of the credit available, your score might only improve by a couple of points. 

There are other factors in play besides your credit utilisation rates. Paying off your credit card debt will only boost your credit score if you pay using your own money. Taking out debt consolidation loans to pay off your credit cards won’t improve your credit score–although it can cut the interest you pay. To start saving the money you need to pay off your debts, open a high-interest savings bank account, and start growing your assets. 

Note: If you’re looking for ways to save money, please visit WeMoney’s Offers to find out how we can help you save money, consolidate personal loan debt, and raise your credit scores.

Does paying the debt in full help your credit score?

There’s a common misconception that paying your debts in full will help your credit score. The truth is there’s no guarantee of a credit score change. Paying off your debt hurts your credit score in the short term, and you could see a score drop after payment. In the long term, it is good to pay your debts as it lowers your credit utilisation ratio, but you should always leave a line of credit open to build your score over time.

Related: How to refinance your car loan?

Why did my credit score drop 40 points after paying off debt?

As we’ve said, paying off your debts in one go can negatively impact your credit score. Here’s a breakdown of why your score might have significantly dropped: 

• You paid off your lowest balance credit card: Your balances across all credit cards make up 30 per cent of your overall score. If you paid off your card with the lowest balance, it would bring down the average credit you owe, and your only remaining accounts will have higher balances. This will affect your credit score, which will also affect your available credit. 
• You closed all your credit cards: Paying off credit cards is good, but not if you close all your lines of credit. Your varying lines of credit make up 10 per cent of your FICO scores, so don’t close the account. 
• Another reason is: Sometimes it’s unclear what’s hurting your credit, mainly because a number of factors contribute to your overall score. A score change could be from a late payment, taking out emergency loans, or quickly racking up a lot of debt on a credit card. 

Read our recent article ‘how can you revive your credit score?’ for ways to counteract lowering your credit. 

Important: If you’re looking to find out how much your current repayments are, or estimate future or ongoing costs, then head on over to the calculator section, which has calculators for home repayments, loan comparison, and personal loans.

How do you get an 800 credit score?

Getting an 800 credit score means you’ll have one of the best FICO scores possible, which will take a lot of financial planning. To achieve an 800 credit score, you’ll need to make many positive financial decisions, likely have a long credit history, and only use a small amount of your utilisation rate. Before aiming for an 800 credit score, check your existing credit score range to identify the easiest ways to start building credit. 

Here’s the best way to achieve excellent credit and get an 800 credit score: 

• Pay your bills on time: Your ability to pay on time is one of the biggest factors contributing to your credit score. Make your bill payment time. 
• Understand your credit history: The longer your credit history, the better your credit score will probably be. The average age of someone with an 800 credit score is typically over 40. 
• Keep your credit card debt low: To improve your credit utilisation ratio, keep your credit card debt below 30 per cent. For example, if you have a $10k spending limit, keep your debt below $3k. 

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Summing up

So, does paying off a loan improve credit? Well, yes and no. While paying off your debts in one go can hurt your credit in the short term, it allows creditors to see that you’re reliable and can pay your bills on time. 

There are pros and cons to paying your debts in one go, but we recommend keeping a few lines of credit open to benefit your score. 

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Disclaimer: The author is not a financial advisor and the information provided is general in nature and was prepared for information purposes only. This article should not be considered to constitute financial advice. Accordingly, reliance should not be placed on this article as the basis for making an investment, financial or other decision. This information does not take into account your investment objectives, particular needs, or financial situation.