Credit score

Why Your Credit Score May Drop After Paying Off Your Personal Loan

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Paying off a loan can feel like a burden on your shoulders, especially if being in debt makes you uncomfortable. But there are other benefits to focusing on paying off debt, like improving your debt-to-equity ratio and increasing your credit score.

Generally, paying off revolving debt like credit card balances can help improve your credit score, assuming no other payments have been made late and you don’t sign up for multiple new lines. credit at the same time.

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

Remember 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 still be recovered over time by continuing positive credit management habits, such as keeping credit utilization low and never missing a payment.

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The average age of your accounts has now decreased

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

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

You now have a less diversified credit mix

Another important factor in determining your credit score is credit mix. Credit makeup only makes up 10% of your FICO score, but it’s still an important part of determining your creditworthiness. Credit reporting agencies want to make sure you have a track record of effectively handling different types of credit, including credit cards, car 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 revolving form of credit and personal loans are a form of installment credit.

With revolving credit, you are given a limit and can repeatedly borrow as much money as you need up to that limit as long as you repay what you borrow. But with installment credit, you have a set time to repay the full amount you borrowed, and it’s usually repaid in fixed monthly installments. Different lenders have different repayment periods (i.e. loan terms) – personal loans from Reachedfor 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 it, you’ll end up with a much less diverse credit mix, which could be a reason to see a drop in your credit score.

Beginner personal loans

  • Annual Percentage Rate (APR)

  • Purpose of the loan

    Debt consolidation, credit card refinancing, marriage, moving or medical

  • Loan amounts

  • terms

  • Credit needed

    FICO or Vantage score of 600 (but will accept applicants whose credit history is so poor that they have no credit score)

  • Assembly costs

    0% to 8% of target amount

  • Prepayment penalty

  • Late charge

    Greater of 5% of monthly amount past due or $15

OneMain Financial Personal Loans

  • Annual Percentage Rate (APR)

  • Purpose of the loan

    Debt consolidation, big expenses, emergency expenses

  • Loan amounts

  • terms

  • Credit needed

  • Assembly costs

    Flat fee from $25 to $1,000 or percentage ranging from 1% to 10% (depending on your state)

  • Prepayment penalty

  • Late charge

    Up to $30 per late payment or up to 15% (depending on your state)

You recently applied for another line of credit

Of course, you may also wonder if paying off your personal loan and dropping your credit rating 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, because applying for a new line of credit opens up a deep investigation into your credit report, and increasing your credit card spending means an increase in your credit utilization rate.

Credit usage is a measure of how much credit you are using compared to how much credit you have. Generally, a high utilization rate indicates that you are using too much credit, which is why experts generally recommend keeping this rate below 30% to maintain a healthy position.

At the end of the line

Paying off a personal loan can have an effect on your credit score, but ultimately the magnitude of the impact depends on your credit profile, including how long you’ve had open credit accounts, diversity 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, by continuing to make on-time payments on your other accounts and keeping your credit in mind. using it can help boost your credit score.

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Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.