Why Did My Credit Score Drop When My Balance Decreased?

Hey there! It’s not uncommon for your credit score to decrease when your debt balance goes down. There are a couple of reasons why this might happen, so let’s dive into it. One possible reason is that when you close accounts, it can affect the diversity and age ranges of your credit accounts, which can in turn impact your credit score. Another thing to keep in mind is that any negative actions, like late payments, that occur around the same time can also bring down your credit score. It all comes down to how credit reports and credit scoring models work. Understanding this in more detail can be really helpful in making sense of fluctuations in your credit score as you work towards financial freedom. So, let’s delve into what information is included in your credit report, how it translates into a three-digit credit score, and what factors might contribute to temporary drops, such as credit utilization and the age of your accounts.

Welcome to Understanding Your Credit Report!

Your credit report plays a vital role in your overall financial well-being. It is used not only by lenders, but also by landlords, insurance companies, and employers. Let’s dive in and learn how it works!

The Three Major Credit Bureaus

In the United States, there are three major credit bureaus – Experian, Equifax, and TransUnion. Each of them compiles an individual credit report for consumers. The good news is that you have the legal right to request a free copy of your credit report from each bureau once a year. Surprisingly, a recent survey conducted in 2020 showed that only 33% of Americans checked their credit reports within the past year.¹ Your credit report includes important information about your credit accounts, credit inquiries, public records, and collection accounts. It also contains personally-identifying details to connect you to your report for easy access.

How Credit Scores are Calculated?

There are various credit scoring models available, but the most common ones are the FICO score and VantageScore. These models use five categories to calculate your three-digit credit score. Each category accounts for a different percentage of your score’s calculation. Here’s the general formula most credit scores follow:

Category	Percentage
Payment History	35%
Amount Owed/Credit Utilization Rate	30%
Length of Credit History	15%
Credit Mix	10%
New Credit	10%

Let’s go into more detail about each category:

Payment History

Your payment history, which includes all the credit accounts on your report, makes up 35% of your credit score. This is the most significant portion of your score, so it’s crucial to make your payments on time to maintain a positive payment history for good credit scores. Late payments can stay on your report for up to seven years.

Amount Owed/Credit Utilization Rate

30% of your credit score is determined by your overall credit usage, including the total amounts owed in revolving credit and loans. Your credit utilization ratio plays a big role in this category and can greatly affect your score as you pay off your debt. Most financial experts recommend keeping your credit utilization below 30%.

Length of Credit History

The length of your credit history accounts for 15% of your credit score. It considers the age of your oldest and newest accounts, as well as the overall average account age. A longer credit history generally leads to better credit scores. Closing credit card accounts usually doesn’t have a significant impact unless it’s an account you closed many years ago. Closed accounts can remain on your report for up to 10 years.

Credit Mix

The variety of credit you have contributes 10% to your credit score. This category aims to encourage a diverse credit mix rather than relying on just one type of credit account. Account types can include personal loans, credit cards, auto loans, mortgage loans, and more.

New Credit

Whenever you apply for a new loan or credit card, the issuer or lender will pull a copy of your credit report. Each of these instances creates a new hard inquiry on your report. Having too many hard inquiries within a short period of time can negatively impact your credit. Be mindful of this when applying for new credit. ¹ Source: Survey conducted in 2020. Even if you’re making all the right moves to improve your finances, it’s possible to see a drop in your credit score. While this can be frustrating, if it’s due to a decrease in your credit card balance, it’s likely to even out soon. There are several reasons why you might experience changes in your credit score while paying off debts. Although most of these reasons are temporary and minor, it’s helpful to be aware of them so you can minimize any damage and rebuild your credit more quickly.

Changes in Credit Utilization

A significant shift in your credit utilization ratio will impact your credit score. Ideally, you should have a higher credit limit and lower credit usage. If your total credit limit suddenly decreases due to a closed credit card account, your credit utilization rate will likely increase, causing your credit score to drop. However, remember that the closed account will still be visible in your credit history, but its credit limit won’t be included in your available credit.

Lack of Credit Diversity

If you’re paying off a variety of debts, you may experience a temporary decrease in your credit score due to a change in your credit mix. Paying off a car loan is a significant achievement, but having only one type of debt left on your report can decrease your score. Therefore, it’s beneficial to have a diverse range of active accounts.

Average Age of Credit Accounts

If you closed some accounts a while ago, especially if they were your oldest accounts, your credit score may be affected. The average age of your credit accounts, as well as the age of your oldest account, are important factors in determining the stability of your credit history. A significant shift in the age of your credit history can lead to a credit score drop, which may require efforts to rebuild your credit. Fortunately, there are several actions you can take to minimize any negative impact on your credit score while paying off your debt. Additionally, there are numerous ways to rebuild your credit after experiencing a decrease in your score. Here are some friendly suggestions on how to keep your credit in good shape before or after a score drop:

Keep Your Credit Accounts Open

After paying off a credit card balance, it’s advisable to refrain from closing the account right away. Although it may be tempting to close the card to achieve a sense of finality, keeping the account open can help protect your credit utilization ratio. Consider maintaining the account without actually using the card. If the credit card issuer requires you to carry a balance, you can simply use the card for automated payments on small expenses, such as your Netflix subscription. You can then pay off the charge every month, allowing you to keep the card open without regular usage.

Use Credit Sparingly and Responsibly

As you progress towards reducing your debt, it’s important to continue using credit responsibly. Utilize any remaining credit cards you have sparingly to avoid accumulating excessive debt.

Avoid Applying for New Credit

Give your credit time to recover by taking a break from applying for new credit products. Instead, focus on paying off existing debts, such as current loan balances and credit card debt, rather than seeking new credit opportunities.

Regularly Monitor Your Credit Report

According to the Federal Trade Commission (FTC), approximately one in five people has an error on their credit report. Keeping a close eye on your credit reports can help you identify and correct any mistakes before they harm your credit score. If you notice any inaccuracies or errors, promptly dispute them with the credit bureaus for resolution.

Consider Paying Off Debt in Full

If possible, we recommend paying off the entire balance of your loans and credit cards. This not only helps you save a significant amount of money on interest but also keeps your credit utilization as low as possible. How do missed payments impact credit scores compared to high credit usage? Missed payments can have a significant negative impact on credit scores, often more than high credit usage. This is because payment history is the most significant factor that impacts credit. It’s important to prioritize making on-time debt payments to maintain a healthy score. If I request an increase in my credit limit on a revolving account, will it affect my credit score? Requesting a credit limit increase might result in a temporary “hard inquiry” on your credit report, which can cause a slight drop in credit scores. However, if approved, a higher credit limit can reduce your credit usage ratio, potentially benefiting your score in the long run. How does the average age of my credit accounts influence my credit scores? The average age of your credit accounts is a factor in credit scoring. Older accounts can contribute to a good credit score as they demonstrate a longer history of credit management. Opening new accounts can lower this average age, which may cause a temporary drop in credit scores. What’s the difference between available credit and credit limit? Your credit limit is the maximum amount you can borrow, while available credit is the difference between your credit limit and your current balance. Maintaining a higher amount of available credit can have a positive influence on your credit scores. When inquiring about available credit and credit limits, you’ll primarily interact with credit card issuers. Is paying off an installment loan early beneficial for my credit scores? Paying off a loan early can reduce your overall debt, but it may also decrease your credit diversity, which is a factor in credit scores. Although it can lead to a temporary drop, reducing debt is generally beneficial for your long-term financial health. How can I stabilize a fluctuating credit score? Fluctuating credit scores can be caused by various factors, including changes in credit usage, recent inquiries, or updates to your credit report. To stabilize your score, it’s helpful to regularly monitor your credit, ensure timely payments, and maintain a low credit utilization ratio. Does the type of debt payments (credit cards vs. installment loans) influence how they affect my credit scores? Yes, credit cards are revolving accounts, meaning their balances can be carried from month to month, while installment loans have fixed monthly payments. Credit scores often weigh credit card balances more heavily, so reducing this type of debt can have a more immediate positive effect on your score. Did you know your credit score can sometimes drop after paying off a balance? It’s not the balance decrease itself that brings down your score, but rather other actions that might coincide with paying off the debt, like late payments. But don’t worry, staying informed about your credit reports is crucial! It’s also important to understand what can harm or improve your credit. If you want to learn more about credit scores, reports, and finances in general, check out Pachyy’s blogs! For more information, you can refer to the following references:

1. 15+ Credit Score Statistics for 2023 | Finnmasters
2. How Common are Credit Report Errors | McCarthy Law
3. Why Credit Scores Could Drop After Paying Off Credit Cards | Experian
4. Why Did My Credit Score Drop? | Capital One