Many individuals are puzzled when they notice a decline in their credit score after making what seems to be a positive financial move – paying off an installment loan. If you’re among those wondering why your credit score dropped after paying off an installment loan (student, auto, installment, mortgage), this article is here to provide clarity.
Remember, credit scores were primarily designed to calculate the risk of you defaulting on a loan. They weren’t created to save you the most money, hence they may not always behave in ways that seem logical to us.
The Closure of Active Installment Loans
When you pay down an installment loan to zero, the loan is closed. Analysis has found that individuals with no active installment loans represent higher risk of default than those who have installment loans actively being repaid. A loan closure eliminates this active credit information, which can lead to a drop in your credit score.
Note: Closed loans will still stay on your credit report and can effect your score in other ways.
The Temporary Nature of the Score Drop
The good news is that any drop in your credit score from paying off an installment loan should be small and recover quickly. It never makes sense to continue paying interest on a loan simply to avoid a small, temporary drop in your credit score.
High Scores Without Installment Loans
It’s essential to note that there are plenty of people with high credit scores who don’t have installment loans. This shows that having a diversity of credit is beneficial, but it’s not the only factor that determines your credit score.
Unrelated Factors Potentially Affecting Your Score
It’s also possible that the drop in your credit score coincided with the repayment of your installment loan but wasn’t directly caused by it. Other factors, like a late payment on a different account or an aging credit history, could also have led to the score decrease.
No Need to Worry Over Small Drops
It’s crucial not to overreact to small drops in your credit score. These are typical and are part of the dynamic nature of credit scoring models. The focus should be on maintaining overall good financial habits.
In conclusion, while paying off an installment loan can sometimes lead to a small drop in your credit score, it is a positive financial step. Maintaining good credit habits and responsible borrowing is more crucial for building a robust credit history over time.