Does it hurt your credit to pay off a credit card all at once?

The Paradox of Paying Off Your Credit Card: Can it Actually Hurt Your Credit Score?

We’re often told that paying off debt is good for our financial health, and that’s generally true. However, when it comes to credit cards, the seemingly virtuous act of paying off the balance in full, especially when followed by closing the account, can sometimes trigger an unexpected dip in your credit score. This might seem counterintuitive, but understanding the underlying mechanisms of credit scoring can help explain why.

The culprit lies in a key factor used to calculate your credit score: credit utilization ratio. This ratio represents the amount of credit you’re currently using compared to your total available credit limit across all your accounts. Credit bureaus view keeping this ratio low as a sign of responsible credit management. Ideally, you want to keep your utilization below 30%, and some experts even recommend staying below 10%.

Here’s where paying off and closing a credit card can backfire:

• Reduction in Available Credit: When you close a credit card, you effectively reduce your total available credit. If you had, say, $5,000 available credit and used $1,000, your utilization was 20%. Now, if you close that card with the $5,000 limit and have no other credit cards, your utilization instantly shoots to 100%, even though you’re not actively using any credit! This sudden spike can negatively impact your credit score.

• Overall Credit Profile Changes: Closing accounts, especially older ones, can also shorten your credit history and potentially reduce the diversity of your credit mix (the different types of credit you use). While the age of your oldest credit account is usually considered more significant, closing older accounts can still have a minor effect.

The Good News: The Impact is Usually Temporary

It’s important to remember that the impact of paying off and closing a credit card is usually temporary. As time passes and you continue to demonstrate responsible credit management, your score will likely recover. The closed account will remain on your credit report for up to 10 years, continuing to contribute (albeit less significantly) to your credit history.

A Smarter Strategy: Consider Keeping the Account Open (and Active)

Instead of closing a paid-off credit card, consider keeping it open, even if you don’t actively use it. A better strategy for maximizing your credit score and demonstrating responsible credit management is:

• Keep the Account Open: Maintaining the account preserves your available credit, helping to keep your credit utilization ratio low.
• Use it Sparingly: Make small purchases on the card once a month or every few months, like a cup of coffee or a streaming service subscription.
• Pay it Off Immediately: Always pay off the balance in full and on time. This demonstrates responsible credit usage and prevents interest charges from accumulating.

By adopting this approach, you’re able to reap the benefits of a higher credit limit without risking debt or overspending.

In Conclusion:

Paying off a credit card is generally a positive step towards financial responsibility. However, before you close that account, consider the potential impact on your credit score. By understanding the nuances of credit utilization and credit history, you can make informed decisions that will help you maintain or even improve your creditworthiness in the long run. Keep the account open and active with minimal usage, and you’ll likely see a healthier credit score for years to come.