Paying off the debt in time is one of the most important criteria to prove you are financially responsible. Timely repayment shows that you have a stable financial condition and you maintain a strong obligation to income ratio with minimum liabilities.
However, many borrowers often see a drop in their CIBIL score immediately after paying off their debt. It happens because how your credit score is calculated. Although it seems counterproductive, it does not affect your score in the long run.
Why paying off debt can affect your credit score?
There are various reasons why your credit score drops after paying off a debt. Let’s take a look at the causes.
Absence of a credit account
Your credit score depends on various parameters like the number of loan accounts, the average age of the accounts, etc. Generally, older accounts have a larger impact on your CIBIL score.
When you pay off a loan and close the existing account, the immediate absence causes your score to drop to some extent. However, if your account does not have any adverse credit history like late payments or defaults, the credit bureaus will exclude it while they calculate your credit score. It will help your score to increase after a few years.
Mix of credit accounts
Your CIBIL score also depends on the number of secured or unsecured credit accounts that is in your name. When you pay off a debt, that mix can show an incline towards secured or unsecured credits. It can affect your credit score.
If you face this issue, the best way how to improve CIBIL score will be another advance to even out the types of credits in your profile. For example, if you have too many credits in place, you can take a personal loan to reconcile all the number of credits in your account. Various financial institutions offer easy to meet personal loan eligibility criteria on unsecured credits that come with multiple features and benefits.
Reduction in credit utilisation ratio
When you pay off a debt and close a loan account it causes an immediate decrease in your credit utilisation ratio. When an account closes the total of available credit drops, which increases the percentage of revolving credit that is in use. That increase causes your CIBIL score to rise immediately after you pay off the debt.
The surge in the debt utilisation ratio will come back to normal once credit bureaus recognise that particular account as ‘Closed’. It will read just your credit score and help it to improve.
Paying off your debt helps your CIBIL rating to improve in the long run. You can utilise it properly to create a good credit history and make yourself creditworthy for another advance in the future.
Here are a few tips to improve your credit score by paying off a debt.
Practice timely repayments
Paying your dues in time is one of the easiest ways to improve your CIBIL rating. Timely repayments and no history of defaults will prove that you are financially responsible. It will positively affect your CIBIL score and help you secure another credit in the future.
You can create a budget to help maintain a balance between your expenses, obligations, and income. Also, remember to choose low interest rates on personal loans to prevent straining your budget while you pay the EMIs. You can use a personal loan EMI calculator to determine a suitable rate of EMI before you apply for a loan.
Do not apply for another credit instantly
If you want to know how to apply for a personal loan without affecting your credit score, you should maintain at least 6 months of time between paying off a debt and asking for another advance. If a borrower applies for multiple loans in a short period, the credit bureaus consider him or her too dependent on loans, which affects their credit score negatively.
Do not pre-pay the loan – Another way to improve your credit score is by maintaining an older loan account with a history of timely repayments. To do that, try to pay your EMIs in time and opt out of a pre-payment. It will reflect positively in your credit profile and improve your CIBIL rating in due course.
Paying off your debt improves your credit score in the long run. Even if the immediate drop may seem detrimental, the credit bureaus will boost your score once they acknowledge the closure of the account with no adverse payment history. It will create the desired credit history on your profile and improve your personal loan eligibility for the future.
