Does Paying Off Debt Fast Hurt Your Credit Score?

Playing Sonic the Hedgehog when paying off debt isn’t the best way to bump up your credit score. Why? When you pay off debt, you undiversfy your credit mix and could lose the long-standing histories you have with credit providers. Credit mix and length of history are two crucial aspects of credit score calculation.

On the other hand, paying off debt if you have a large amount can increase your credit score by bringing down your credit utilisation rate. If your credit score does dip, it’ll go back up within a month or two. You’ll reduce your DTI (debt-to-income) ratio, save on interest, and enjoy a myriad of other benefits.

This post discusses how to pay off debt fast, why it would or wouldn’t bring down your credit score, and the benefits of paying off debt.

Why paying off debt too quickly could harm your credit score

The factors impacting your credit score include credit history, credit utilisation rate (how much credit you use compared to what you have available), DTI, credit mix diversity, and length of credit history. Reducing the number of accounts in your credit mix could very well also decrease your credit score. Similarly, lessening the number of accounts contributing to the overall length of your credit history could reduce your credit score.

How paying off debt could save your credit score

On the other hand, paying off debt could help your credit score, especially if you’re over-indebted or your credit utilisation rate is quite high. The ideal credit utilisation rate is 30% or below. So, if your utilisation rate is 50% (you use half of the credit you have available) or more, we recommend paying off your debt. Plus, paying off debt when you’re under debt review or an administration order could help you get your clearance certificate faster.

Paying off debt saves you money

When you pay off debt, you can save on interest. Let’s say you pay off your debt a year early. That’s 12 APR (annual percentage rate) payments you save on.

You’re also able to take out more loans when you pay off loans. That’s because you’ll lower your DTI: the ratio lenders use to assess whether you can afford to take out more finance.

How to pay off debt

There are two big ways you could pay off debt: the snowball method and the avalanche method. The snowball method works by starting with your smallest debt, then progressing to a larger debt and so on, whereas the avalanche method works by paying off debt with the highest interest rate first. The avalanche method helps to provide a sense of gratification, as it’s easier to feel motivated when you’ve paid off a smaller debt first. The avalanche method could save you money in the long run, particularly if you have a large debt with a high interest rate, like a big 90-day loan.

Paying off debt is a fantastic way to save money, reduce your credit utilisation rate and DTI ratio, and raise your credit score in the long run. Don’t pay off debt if it’s going to eat into an emergency fund or you expect to have your credit checked in the future (like applying for a mortgage or insurance).

If you need assistance paying off debt or feel that you have overwhelming debt, contact Debtco Group. We’re experts in finance and negotiating with creditors to reduce interest rates and repayments. We can also protect you from legal action.