If you find yourself with some extra cash, paying off one of your credit cards might be tempting. You eliminate a monthly bill and the interest charges that go with it. Of course, you don’t want to do anything that will make your credit score drop. A lump sum payoff raises your credit score, as long as you don't close the account afterward.
If you pay your credit card completely off and keep the account open, it will have a positive effect on your credit score since you have reduced your overall debt and credit utilization. Closing the account, however, can hurt your credit score since your length of credit history is a factor.
When you pay off a credit card, you reduce the amount you owe compared to your available credit. Part of your credit score is based on this credit-utilization ratio. Credit Karma recommends keeping your overall card utilization under 30 percent. Anything higher suggests to lenders that you may rely to heavily on credit. Paying off the card brings the percentage to zero, which is good for your score. However, if you close the account, it comes off your credit report and won’t be there to improve your credit score.
Aggregate Credit Utilization
Credit utilization for each separate account is factored into a credit score. In addition, the overall credit utilization counts. Suppose you have two credit cards (each with a $2,500 limit) and make a lump sum payment to pay off one. The other still has a $1,000 balance. If both accounts remain open, your overall credit utilization is 20 percent. If you close the paid-off card account, the overall utilization percentage now jumps to 40 percent, even though you haven’t charged anything extra. A jump like this is likely to take points off your credit score.
The Impact of Time
Part of a credit score measures the length of your credit history; the age of your accounts matters and counts for up to 15 percent of the score. If you make a lump sum payment to pay off a credit card, it won’t affect this part of your credit score provided you keep the account open. If you close the account, the contribution the account makes to the length of your credit history is lost, and your score may drop as a result.
Keep Your Card Alive
You may not need to use a credit card after you’ve paid it off. Some credit card providers are OK with this and will keep an unused account open indefinitely. Others review accounts periodically and close inactive accounts. An account closing of this nature doesn’t put a negative mark on your credit record, but you lose the benefits the account has for your credit score. One option is to use the card occasionally to make a purchase and then pay the charge off when the monthly bill arrives.