Dear Credit Card Adviser,
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I paid off all of my credit cards and some other debt I had with inheritance money I received. Then I heard it will hurt my credit score by paying them off. Is this true? I hope not. I thought I was doing the right thing by taking care of my debt.
There's no specific score penalty for paying off credit card balances. However, if your credit score is pulled after the zero balance appears on your credit report, you might see a difference in your score compared to what it was before.
That's because your balance-to-credit limit ratio, or revolving utilization, will have changed. For the FICO score, a credit score widely used by lenders, utilization is part of the amounts-owed category, which is worth 30% of your score. The most heavily weighted category, at 35%, is your payment history.
Obviously, paying off your balance will lower your utilization down to zero for that account. Utilization is calculated for individual accounts and across all revolving accounts.
As FICO consumer affairs manager Barry Paperno said recently in an interview: "The idea here is the lower, the better, in terms of the utilization percentage, but something is better than nothing."
That is, you'll get slightly fewer points for having a zero balance compared to having the lowest utilization percentage. In your specific case, the downward change in utilization likely would be beneficial.
As Paperno said, "Compared to having a 10%, 20%, 30% utilization, it's much better to have a zero balance."
Paying off your debt could "hurt" your credit score slightly if you have zero balances on all of your revolving accounts at the same time. That penalty would disappear once you use your cards again.
If you swear off using credit cards again and your issuers eventually close the accounts for inactivity or stop updating them with the credit reporting agencies, your score could at that point take a hit.
Luckily, once you pay off your credit card debt, you'll be in a great position to manage your credit cards and your finances. Use your cards lightly and pay the balance in full each month to stay out of debt to get the maximum credit score benefit from utilization.