Debt Free? Don't "Lose" Your Credit Score

The CreditExperts at Credit.com recently received this question from a reader:

Hi, I have a 532 credit score at this point because I lost my job in 2008 and was forced to take another at a reduced pay scale. I have debt but will be paying all of it off in September. Will this raise my credit score or lower it, since I have no active credit cards or loans in my name?

Congratulations on becoming debt-free next month (September)! It’s an especially impressive feat considering you’ve lived on a reduced income for the past four years.

While your question of whether your score will go up or down is a good one, the more important question in your situation might actually be whether you will even have a credit score for very long after paying your loan in full. Losing your score entirely, if that were to happen, wouldn’t occur over night, but could happen after as little as one month if the loan you’re paying off is the last recently reported (updated) account on your credit report. (If you want to monitor your score for free, you can do so by signing up for Credit.com’s Credit Report Card.)

How do you lose your credit score? Since credit scoring formulas require at least one piece of recently updated information on your credit report before a score can be calculated, retiring your regularly updated loan debt after having already stopped using credit cards may have the effect of closing down the only item on your credit report that’s currently triggering a credit score. (Note: while this may be the only score “triggering” item on your report, all of the information on your credit report is included in the score that’s calculated.)

To avoid losing your credit score, make sure at least one active account appears on your credit report by either:

1) opening a secured credit card that you then use occasionally and quickly pay off without incurring finance charges; 2) opening a small (secured or unsecured) personal loan from a bank or credit union; or 3) having someone you trust add you as an authorized user to one of their active credit cards, so that their regularly-updated account can be added to your credit report and included in your credit score.

Lastly, to answer your question regarding the initial raising or lowering your score when you pay off the loan, I wouldn’t expect to see an immediate improvement in your score, primarily because the credit scoring formulas give more weight — both positive and negative — to credit cards than installment loans. Also, no longer having an open installment loan on your credit report could hurt your “mix” of credit, where the scoring formulas like to see a mix of both revolving and open installment accounts.

Again, kudos for paying off your debt! Now, just make sure you continue to maintain at least one regularly updated account on your credit report, so you can watch that 532 score steadily increase over time now that you’re debt free.

[Free Resource: Check your credit score and report card for free with Credit.com]

Image: Ksayer1, via Flickr