A credit score doesn’t necessarily work the way that interested individuals might expect. As a result, it is possible for strange things to happen from time to time, with an excellent example being the credit score falling after an account has been paid off.
Fortunately, there is a simple explanation for why your credit score may drop when this happens.
Something that should make it easier for you to answer the question, “Should you pay off all of your debt?”
Why Can Your Credit Score Drop After You Pay Off a Debt?
There are five components to a credit score. For those who are unfamiliar, these would be the payment history, the amount of utilized credit relative to total available credit, the length of credit history, the mix of credit that is being used, and the number of recent hard inquiries.
It shouldn’t be hard to see why these factors are believed to be useful for gauging a person’s creditworthiness. Still, it is possible for them to produce unintuitive outcomes from time to time.
Paying off a debt seems like it should be a positive thing. However, it can impact some of these factors in a negative way, meaning that it can lower a person’s credit score under certain circumstances. For example, it is possible that the account that was paid off was the only example of its kind of financial product associated with the individual.
This is bad because lenders like to see people using a wide range of financial products, which shows that they are better at handling them in general. Similarly, losing a long-running account can be bad for the length of credit history.
Lenders like that one because a longer credit history is more reliable than a shorter credit history, if only because there is more information that can be used to make predictions about someone’s creditworthiness. On top of this, it is even possible for a closed account to increase the amount of utilized credit relative to total available credit by reducing total available credit.
Should This Stop You From Paying Off All of a Collection Account?
These considerations extend to collection accounts. As a result, it is possible for you to see a decrease in your credit score even when you pay off a collection account. That can seem strange. Even so, collection accounts impact the credit score through the same ways as everything else.
Please note that this shouldn’t prevent you from paying off your collection accounts. Yes, there are circumstances under which doing so can decrease your credit score.
However, the fundamental fact of the matter is that paying off your collection accounts is important for restoring your creditworthiness in the long run. Against this, a decrease in your credit score in the short run means very little.
This is particularly true because lenders are capable of looking beyond the credit score, which is important when collection accounts tend to make them less than enthused about lending money to interested individuals.
Having said this, there can be circumstances under which you might not want to pay off all of your debt as soon as possible. To name an example, you might have other financial goals that are important in their own right. As a result, you need to balance them with the financial goal of becoming debt-free. Due to this, it is a good idea for you to think about everything that will be affected if you are wondering what you should be focusing upon.
Summed up, there isn’t a universal answer to the question of “Should you pay off all of your debt?” You should definitely do so for collection accounts for the sake of your creditworthiness. However, other debts can be more complicated, meaning that you will need to evaluate each one on a case-by-case basis.