Credit scores are three-digit numbers that are calculated based on information from your personal credit usage. This includes your payment history, the total amount that you owe, the age of your oldest account, new credit and type(s) of credit in your name. It’s important to note that not all factors have the same impact — payment history makes up 35 percent of your score, the amount you owe accounts for 30 percent, credit history length affects 15 percent, and both credit mix and new credit make up 10 percent.
When you repay debt, a few factors can affect your score. We’ll show you a few different ways that your score can improve when you repay or eliminate debt.
What Happens to Your Credit When You Repay Some Debt?
We’ll assume that you have at least one form of debt, like a credit card or personal loan, and that you don’t continue to use more credit as you repay the balance. If you make on-time payments to lower your debt, you can positively affect your credit score over time. Making larger, more aggressive payments may help you raise your score faster than paying just the minimum amounts due.
However, if you continue to use credit without making headway on your credit utilization ratio, or the percentage of your total credit that you’re using, your credit score likely won’t raise much, if at all. In fact, if you increase your utilization ratio or make any late payments, you could actually lower your credit score. Aim to keep your total credit utilization ratio at 30 percent or less. For example:
Eric has 3 different personal credit accounts: a $2,000 personal loan he recently took out and two credit cards. According to his most recent statements, his total outstanding debt totals $4,500, and his total credit limit is $10,000. To find his utilization ratio, he’ll divide his total debt balance by his credit limit and multiply by 100 for the percentage:
$4,500/$10,000*100 = 45 percent
With a 45 percent utilization ratio, Eric is using almost half of his available personal credit, which might make it harder to keep up with payments!
What Happens to Your Credit When You Repay All Debt?
When you eliminate all of your debt, your score should improve because a third of it is determined by your outstanding amount owed. And if you had a fair or poor credit rating before you repaid debt, your score could improve significantly. Maintaining responsible credit habits can help you steadily improve your score.
How Does Closing a Credit Account Affect Your Credit?
If you pay off a debt, like a credit card or revolving loan, it might seem logical to close that account. However, doing so could actually lower your credit score. This can happen for multiple reasons — for instance, the average age of your accounts lowers temporarily, which accounts for 15 percent of your score. Additionally, closing a credit account also reduces your total credit limit. So if you use credit again in the future, you’d have a higher utilization ratio than if you kept the credit line open, which can lower your score.1
It’s usually not necessary to close most credit accounts once you’ve repaid your debt; depending on the type of account, it might be beneficial to have quick access to credit when you need it again.
1McGurran, B. (2019). Should You Cancel Unused Credit Cards or Keep Them?