6 Reasons Why Paying your Debt Down Doesn’t Mean Your Credit Score Will Improve Immediately


Paying down your debt always feels good and now you’re determined that you’re going to pay it off once and for all. Besides the benefit of reducing your monthly obligations, you’ve heard that paying down your debts will help your credit; some rumors even say this happens immediately. Is this true?

1. Paying off your Collections will not Help your Credit Score.

Any mention of a collection on your credit report will sink your score.   FICO 9, introduced in August of 2014, is supposed to treat collections differently than previous models. FICO 9 also weighs medical collections differently than other collections, making them less damaging to your score. In addition, FICO 9 will set aside paid collections during their score calculations. Vantage Score 3.0 also gives you a pass if you pay off your collection account.

However, most lenders are not using FICO 9 or VantageScore 3.0. If you apply for a mortgage, you will be getting your FICO 04 score, which does not differentiate between paid and unpaid collections. If you get your credit score any where other than a bank or myfico.com, you will be getting your VantageScore, but this score is used infrequently when banks make credit decisions. For more information about the different types of score and where they are used, see this article.

Eventually, lenders may adapt to the new FICO scoring model; they may even begin to use VantageScore. However, this will not happen in the near future.

Paying off collections will help you qualify for a mortgage, however. Most mortgage companies do not like to see unpaid collections on your credit report, as these are potential lawsuits in the making. Potential lawsuits can lead to liens against your home, and the mortgage company doesn’t want competition in the value of your home if you default. If your credit is approved containing unpaid collections, most companies are going to require that you pay them off before the loan closes.

The good news: as the debt ages, it will hurt your credit score less and less if you are scored using older versions of the FICO score.

2. Paying off Your Auto Loan Does Not Improve Your Score

An auto loan is an installment loan, and the balances of installment loans do not affect your credit score in any way. It’s only the payment history that counts for or against you when calculating your score: timely payments help, delinquent payments hurt. After paying off your loan, you may feel relief at not having to make that payment any longer. However, the only way this paid off loan can help your credit score is to take the amount of the auto loan payment and use it to pay down your credit cards.

If you are applying for a mortgage, having a paid auto loan can help you to qualify, as this payment no longer figures into your debt ratios, which is the total amount of your debt payments (including your mortgage) divided by your monthly income. Most lenders like to see between 36% and 43%, depending on the loan program you choose.

3. Paying off Judgments Will not Improve your Credit Score

Judgments stay on your credit report for 7 years paid or unpaid. While the Fair Credit Reporting Act states that a judgment may stay on your credit report for as long as the statute of limitations in your state is in effect, all three bureaus remove judgments at the 7-year mark whether or not they are paid.

Even if an unpaid judgment falls off of your credit report, until the statute of limitations runs out (in most states it is 10 years), you are in danger of having your wages garnished or having property seized, so paying it off can be a great peace of mind.

Like a collection, paying off a judgment can help you get approved for a mortgage, as lenders will require you to satisfy the judgment before the deal closes.

4. Paying Off Tax Liens Will Generally Improve Your Credit Score in 7 Years

Under the Fair Credit Reporting Act, a tax lien stays on your credit report for 7 years from the time it is paid. An unpaid tax lien can stay on your credit report indefinitely, so paying it off has definite advantages.

If you pay off your tax lien, you may also qualify to get your tax lien withdrawn, which will remove it from your credit report sooner than 7 years. This program is called Fresh Start and is offered by the IRS. In order to qualify for the program, you must:

  • Pay off your lien or have made arrangements to automatically debit your bank account for a set amount of time to pay off the loan.
  • You’ve filed your taxes for 3 years and are compliant
  • You are current on any estimated tax payments and federal tax deposits.

If you successfully apply for the program, the fix is certainly not quick, government programs are known to move at a snail’s pace.

5. Paying Off Your Mortgage Will Not Improve Your Score

Like auto loans, mortgages are installment loans and the balances on the loans do not factor into your credit score. Paying off your mortgage could even make your credit score go down, once the account and the payment history drops off of your credit report (inactive accounts generally stay on for 10 years). Your credit score factors into it the mix of credit (10% of your score), and the scoring models typically like to see that a consumer has at least one installment loan along with revolving credit like credit cards.

6. Paying Down Credit Cards Will Have the Quickest Effect, but It’s Still not Immediate

Your credit utilization ratio (percentage of the amount of available credit you use on your credit cards) is 30% of your credit score in the FICO model and 23% in the VantageScore model. Paying down your credit cards can have a large effect on your credit score, relatively rapidly. Only your payment history has a bigger effect on your score (it comprises 35%). Most scoring models like to see your credit utilization at or below 30%.

However, your bank only reports your balances to the credit bureaus once a month. Even if you pay off your credit cards in full each month, the amount of the existing balance on the reporting date is sent back to the credit bureaus. I pay my own credit cards off each month, and I never show a zero balance on my credit cards on my credit report.

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