Should You Pay Off All Debt to Improve Your Credit Score?

When it comes to financial health, your credit score holds great importance. Whether you are applying for a new loan or taking out a new insurance plan, your credit score can help you get better terms and rates at every step. 

While it’s a well-known practice to make timely payments to improve your credit score, it’s a bit tricky to understand if paying off your debt helps you with that goal. This happens due to the many factors that are involved in calculating your credit score. 

To help you solve this puzzle and strengthen your finances, here’s a detailed guide that tells you if paying off all debt can improve your credit score. 

How Debt Impacts Your Credit Score

Your credit score is built on many factors, with the debt that you have in your name playing a major role. When you take out some debt as a part of practicing financial management tips for entrepreneurs or professionals, it can help you start building and improving your credit score. Here, you need to be careful about the following factors that influence your credit score. 

Credit Mix

Your credit mix comprises the type of credit accounts or lending accounts that you have in your name. This includes installment credit like student loans and revolving credit like credit cards. Having both types of accounts makes for a good credit report. That is why, experts suggest that you have at least one installment credit account and one revolving credit account on your name at all times. 

Credit Utilization Ratio 

Your credit utilization ratio determines how much credit you have used from the total amount granted to you by lenders. Ideally, your credit utilization ratio should be below 30% across all accounts. This means that if you have two credit cards with a total of $1,000 credit limit, you should use no more than $300 across both. This calls for you to use tools like a couples budgeting app to manage your finances.

Debt-to-Income Ratio

Your debt-to-income ratio (DTI) is calculated by dividing your monthly total debt payments by your gross monthly income. If your DTI is more than 35%, it can have a significant impact on your credit score. Due to this reason, it is recommended that you keep your DTI below 35%. This is where following tips to ease financial anxiety can go a long way towards helping you maintain a good credit score. 

With these, other aspects like making timely payments for your debt accounts and maintaining a higher age for your credit history also hold major significance for your credit score. 

How Does Paying Off Debt Affect Your Credit Score?

When you pay off your debt, your action can affect the above factors and cause your credit score to take a hit. This makes it necessary that you pay off your debt carefully in order to maintain a good credit score. The following explanations shed more light on this process. 

It Depends on the Type of Debt You Pay Off

From the best finance podcasts to the most popular money-management videos, several outlets may suggest that you continue to maintain both an installment credit account and a revolving credit account under your name. This means that if you have a student loan, a car loan and two credit cards, you may only want to pay one of your loans early and close one credit card so you can still maintain two different accounts. 

The Amount of Debt You Pay Off Matters

Your credit utilization ratio is determined by how much debt is on your name. If you close an account with a lower amount but have credit cards with higher amounts still in your name with their credit fully used, your credit utilization ratio will increase and drop your credit score. Similar to using a financial health app, you may want to listen to experts and only pay off your credit cards without closing them all off. 

Paying Off Your Oldest Account Takes a Hit to Your Credit Score

Your credit history is also judged by the “age” of your credit, which is calculated by taking the average of all of your credit accounts. The older your credit history, the higher your credit score. That’s why, paying off and closing your oldest account can cause your credit score to drop. You can use a financial advisor platform to weigh the pros and cons of this factor for your specific case. 

Should You Pay Off Your Debts Anyway?

It’s never a bad decision to pay off your debts, especially if they weigh you down with high interest rates or annual fees. But in most cases, paying off the balance of your revolving credit but maintaining your accounts can do the trick. By taking a good look at your finances and seeking expert advice, you can make a decision that is suitable for you.