Paying off debt is a major financial milestone, but does paying off debt raise your credit score? The answer depends on the type of debt, your overall credit profile, and how you handle your accounts after paying them off.

While eliminating debt can improve your financial health, it doesn't always result in an immediate credit score boost. In some cases, it may even cause a slight dip. Let’s look at how paying off debt affects your credit score and how you can maintain or improve it.

The good: Lower credit utilization helps your score

Paying off debt can significantly impact your credit score, primarily by lowering your credit utilization ratio — the percentage of available credit you’re currently using. Because credit utilization is 30% of your credit score, reducing credit card balances can lead to noticeable improvements. Keeping utilization below 30% and ideally under 15% is best for maintaining a strong credit profile.

In addition to revolving credit, paying down installment loans, such as auto or personal loans, can improve your debt-to-income ratio, making you appear more financially stable to lenders. If you want to raise your credit score, prioritizing high-interest revolving debt, like credit cards, is one of the most effective strategies.

The not-so-good: Credit mix and account age may be affected

Paying off debt is always a smart financial move, but it can sometimes result in a temporary drop in your credit score. This slide is typically due to credit mix changes and the average age of your accounts.

If you close a credit card or loan account after paying it off, it may shorten your overall credit history, which could slightly lower your score. Additionally, if the debt you paid off was your only installment loan, it might reduce the diversity of your credit mix — a factor that makes up 10% of your score. Lenders generally prefer a mix of credit types, such as revolving credit (credit cards) and installment loans (auto loans or mortgages).

Fortunately, these effects are usually minor and not very long-lasting. If you continue practicing good credit habits — such as making on-time payments — your credit score will likely rebound.

How paying off debt impacts your credit score

Credit card debt: Net positive

Paying off credit card debt is an incredibly effective way to increase your credit score, as it lowers your credit utilization ratio.

After paying off a credit card balance, consider making small purchases with the card and paying the full amount each month. This activity keeps the account active and demonstrates responsible credit use.

Installment loans: Mixed

Paying off auto loans, personal loans, or mortgages can affect your credit differently.

• Positive: Eliminating debt improves your financial standing, reducing your overall debt load
• Neutral/negative: Your credit mix may be reduced if the loan was your only installment loan. As mentioned above, this can slightly lower your score. Additionally, the loss of an active, positive payment history may trigger the loss of a few points.

However, a positive payment history remains on your credit report for up to 10 years, meaning your credit will still benefit from a paid-off loan in the long run.

Collection accounts: It depends

Paying off a debt in collections has varying effects on your credit score, depending on the scoring model. New credit scoring models like FICO 9 and VantageScore 3.0 generally disregard paid collection accounts when calculating your score. Conversely, some older credit scoring models may still consider paid and unpaid collections, potentially impacting your score negatively.

Regardless of the immediate effect on your credit score, paying off a collection account is a wise financial move. It helps prevent legal action or wage garnishment and allows you to move forward with a cleaner financial record.

Paying off debt should always be your plan

While paying off debt may cause temporary fluctuations in your credit score, the long-term benefits far outweigh any short-term hits. Reducing debt lowers financial stress, improves your creditworthiness, and increases opportunities for better financing terms in the future.

If you've been paying off debt and are ready to purchase a newer vehicle, Credit Acceptance might be able to help. We partner with over 15,000 dealerships nationwide to assist credit-challenged buyers in securing auto financing. Get pre-qualified online for auto financing today!