Will My Credit Score Improve With Balances Paid Off?

Equifax, Experian and TransUnion are the three major credit reporting bureaus in the United States. Each bureau uses the Fair Isaac Corporation consumer credit scoring method, better known as FICO for calculating their scores. Outstanding balances on loans and credit cards account for a large portion of your FICO score. As you pay off these balances, you credit score likely improves, because it reduces the amount of debt you have outstanding.

Credit Score Factors

Your payment history makes up 35 percent of your credit score, and the amount of debt you owe is 30 percent. The length of time you have had credit accounts for 15 percent of your credit score. Different types of credit, and how much new credit you have, each account for 10 percent, making up the remaining 20 percent of your score. Making your payments on time, and keeping your outstanding balances on your credit accounts low, affects your credit score the most.

Credit Limits

When the balances on your credit cards get closer to your credit limit, it increases your minimum monthly payment and tends to decrease your credit score. As you pay those balances down and eventually pay them off, it improves your credit score. Opinions on how much of your available credit you should use varies, but most experts say your credit balances should not be more than 30 to 35 percent of your credit limit.

Collection Accounts

When it comes to credit scores, paying off collection accounts does not automatically increase your score. When creditors sell your account to collection agencies, they do what they call a charge-off. When this happens, your account balance with the original creditor is zero because your balance transfers to the collection agency. Your balance with the original creditor is a bigger factor in your credit score than your balance with the collection agency. Paying off outstanding debts is a good ethical decision, but it may not do anything to improve your credit score.

Debt to Income

When lenders assess your creditworthiness, they examine your debt-to-income ratio along with your credit score. A debt-to-income ratio is a measure of your income as compared to your debt obligations. A low debt-income-ratio is generally better than a high one. When the outstanding balances on credit cards and other revolving lines of credit are high, it increases your debt-to-income ratio, and signifies an increase in your risk of defaulting on new lines of credit. Paying off your outstanding balances not only increases your score, but also lowers your debt-to-income ratio.