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For most people, credit scores are a mystery; even credit experts don't know every last thing about how credit scores are calculated -- and what makes them change. If you pay off credit card debt, for instance, will your credit score go up -- or down? Here's what you need to know.
Here's a short chart showing different methods of paying off credit card debt and how they usually impact your credit score.
|Method used to pay off credit cards||Usual impact on credit score|
|Cash or check||Boost in score|
|Personal loan, debt consolidation loan||Boost in score|
|Cash-out refinance||Boost in score|
|Line of credit, HELOC||No change|
|Balance transfer credit card||No change|
Note: Depending on your circumstances, you may not see these effects on your credit score. We'll explain more about how your credit score is calculated below so you can take all factors into account.
Every consumer's credit history is unique. And most credit scoring agencies don't publish their formulas.
However, FICO -- the most commonly used credit scoring agency -- does publish what types of data it considers, and how much it weighs each factor.
Here are FICO's official scoring factors:
To understand your credit score, ask yourself these five questions:
When companies are deciding your credit score, they compare how much you've borrowed compared to how much credit you have available. The comparison of how much you could spend on credit vs. how much you do spend on credit is your credit utilization rate. It factors into the "Amounts Owed" category of credit scoring.
Here's an example:
|Amount owed on credit card||Credit card limit||Credit utilization ratio||Good or bad?|
FICO looks at your utilization across all of your credit cards, but they also consider the individual utilization of each card. For a good credit score, try to keep your credit utilization at about 30% or less.
Since lower utilization is better, reducing your utilization typically increases your credit score. This is the main part of your score affected when you pay off credit card debt.
The amount your credit score improves depends a lot on how high your utilization was in the first place.
If you're already close to maxing out your credit cards, your credit score could jump 10 points or more when you pay off credit card balances completely.
If you haven't used most of your available credit, you might only gain a few points when you pay off credit card debt. Yes, even if you pay off the cards entirely.
Because your utilization is a ratio of how much you owe versus how much available credit you have, it's important to keep your credit cards open. $0 owed on a card with a $1,000 limit is impressive. $0 owed when you have 0 credit cards doesn't pack the same punch.
You should see your score go up within a month (sometimes less).
Your credit card issuer typically sends an updated report to the credit bureaus once a month when your statement period ends. A new credit score is calculated every time your credit is pulled, and the new score uses the latest balance information. So you should see the results of these payments as soon as your credit card balances update on your credit reports.
This is pretty fast compared to other methods. Some ways of boosting your credit can take months, or even years.
In general, the only time you should see a decrease in your credit score when you pay off credit card debt is if you also close your account. Why? Once again, it mostly comes down to utilization.
As we saw, your credit utilization decreases when you pay off credit card balances. But this only works if your total available credit stays the same.
When you close a credit card, you lose access to that credit line. This means your total available credit decreases. If you have balances on your remaining credit cards, a decrease in your total available credit can cause your utilization rate to rise.
To avoid this, you may want to pay off credit card balances without closing your accounts. Of course, if you have problems using your card responsibly or the card has an annual fee, it may be worthwhile to close the account despite the potential impact to your utilization. In this case, try to pay off all of your credit card balances to keep your overall utilization low.
It's always a good idea to pay off credit card debt, regardless of how that debt repayment impacts your credit scores. Unless you have an intro APR deal, any outstanding balance carried from month to month accrues interest -- at a high interest rate.
Happily, you don't have to choose between paying down high-interest debt and your credit score -- you should almost always see an improvement in your score when you pay off credit card debt. It's hard to predict how much your credit score will change, but hopefully this guide helps you estimate the potential change.
Here are some other questions we've answered:
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