Reasons Why Your Credit Score Drops After Paying the Debt

Paying off a loan without missing an EMI is a proof of healthy and stable finances. However, many borrowers often experience an unwanted drop in their credit score immediately after repaying a debt. It happens because of the process how CIBIL score is calculated, and although it may seem counterproductive, it doesn't affect your credit report in the long run.

To understand why the score drops after closing the loan account, you need to understand some factors that assemble your credit rating. It is a 3-digit number (ranging from 300 to 900) that represents your creditworthiness. Your financial habits, on-time repayments, defaulting, etc. play a crucial role in determining your credit score. A score better than 750 is considered preferable among lenders when you apply for an immediate personal loan.

Reduction in score after paying the debt

●       Closure of credit card accounts – Closing an old credit card account can decrease your credit score temporarily. Your credit history is one of the most important factors used to calculate the score. Closing an old credit account will affect your credit score negatively, especially with a credit history where you have a higher average credit utilisation ratio.

●       Drop in credit utilisation ratio – Paying off a debt like an immediate personal loan is the same as maintaining an average credit utilisation ratio of 50% or lesser. That is the ratio which lenders consider as a highest threshold when they consider a future borrower. A higher debt utilisation ratio will decrease your credit score. However, the utilisation ratio will drop back to normal once the account is acknowledged ‘Closed’ by the credit bureaus.

For personal loans or credit cards, a borrower should aim to pay the EMIs on time other than avoiding a credit utilisation ratio above 30-40%.

Ideally, you should apply for an immediate personal loan from a financial institution that offers competitive interest rates, lets you choose a suitable tenor, and disburse an above substantial capital.

NBFCs offer such borrower-friendly terms on such credits and advances. They also provide pre-approved offers for personal loans, home loans, business loans, and a range of other financial products and services. You only have to share some necessary details online to check your pre-approved offer. It simplifies the process of availing finances simple and time-saving.

How to pay off your debt and improve credit score?

There are some practices you can follow to pay off your debt and improve your credit score in the long run. Let’s take a look –

●       Practice paying on time – Paying your EMIs and credit card dues on time will improve your credit score significantly. You can create a budget to check overspending. Also, remember to choose an EMI and tenor that is affordable for you. You can use an online personal loan EMI calculator to determine the ideal rate.

●       Do not apply for another credit immediately – Ideally, you should wait for at least 6 months before you try to avail another advance. Applying for more than one immediate personal loan within a short time will raise too many ‘hard enquiries’. It will affect your CIBIL score as it will mark you as credit-hungry.

●       Review your credit reports – A simple clerical error can considerably affect your credit score. Experts advise reviewing your credit reports at least once a year for any discrepancies. Payments that go through lengthy processes, such as medical bills, can generate errors at some point in time.

Paying off a debt might immediately impact your creditscore, but it will bounce back within some time. Foreclosing a loan will also improve your rating in the long run, which helps you avail financing at the most affordable terms in the future.