If you find yourself with some extra cash, paying off one of your credit cards might be tempting. You eliminate a monthly bill and the interest charges that go with it. Of course, you don’t want to do anything that will make your credit score drop. A lump sum payoff raises your credit score as long as you don't close the account afterward.
When you pay off a credit card, you reduce the amount you owe compared to your available credit. Part of your credit score is based on this credit-utilization ratio. When you keep your credit card balance below 20 percent of your credit limit, you get the most points added to your credit score. Paying off the card brings the percentage to zero which is good for your score. However, if you close the account, it comes off your credit report and won’t be there to improve your credit score.
Aggregate Credit Utilization
Credit utilization for each separate account is factored into a credit score. In addition, the overall credit utilization counts. Suppose you have two credit cards, each with a $2,500 limit. You make a lump sum payment to pay off one. The other still has a $1,000 balance. If both accounts remain open, your overall credit utilization is 20 percent. If you close the paid-off card account, the overall utilization percentage jumps to 40 percent even though you haven’t charged anything extra. A jump like this is likely to take points off your credit score.
The Impact of Time
Part of a credit score measures the length of your credit history; the age of your accounts matters and counts for up to 15 percent of the score. If you make a lump sum payment to pay off a credit card, it won’t affect this part of your credit score provided you keep the account open. If you close the account, the contribution the account makes to the length of your credit history is lost and your score may drop as a result.
Keep Your Card Alive
You may not need to use a credit card after you’ve paid it off. Some credit card providers are OK with this and will keep an unused account open indefinitely. Others review accounts periodically and close inactive accounts. An account closing of this nature doesn’t put a negative mark on your credit record, but you lose the benefits the account has for your credit score. One option is to use the card occasionally to make a purchase. You can pay the charge off when the monthly bill arrives.
- Digital Vision./Digital Vision/Getty Images