A new credit card is one way to improve your credit mix, which could increase your score as long as you make your payments on time
Dear Keeping Score,
I am 26 and just paid off a car loan, and I still live at home with no debt other than $50-200 a month I pay in full on time with my current (only) credit card. My credit score dropped from 770 to 747 after I paid off my car loan. Since I have no rent or other payments other than my current credit card, should I open another account to increase my credit limit and put a small balance on both my cards every month and pay them off? Would that help my score? Thank you very much for your time and any input. -Joe
First of all, way to go on paying off your car loan! That is a massive accomplishment, and one you should be proud of. While the drop in your score probably feels like you’re being punished for being responsible, that is really not the case.
Let’s start with how you can raise your credit score. There are a number of different ways to do so. No, you don’t need to buy another car. But you do need to use more credit so you can show that you can manage more than one credit obligation at a time.
You could get a second card with no annual fee. You might also consider adding a retail card to your mix. Depending on where you shop, you may get some great coupons for having their card as a bonus.
Since you live at home, you might ask your parents if they would add you as an authorized user on one of their credit card accounts. They don’t need to actually give you a card of your own; just adding you to their account will cause the new card to be reported to your credit file and build more credit data and your score.
If you want to add an installment loan, you might buy a small piece of furniture for your room (or as a gift for letting you live at home) and pay it off using the store’s financing. Be aware that opening new credit will initially cause another small drop in your score due to a hard inquiry, but it will recover in a few months as you make payments on time.
Now, let’s discuss what happened so you’ll know what to expect in the future. While a drop of 23 points may seem big to you, in the world of credit scoring it really is not. Don’t panic – any score above 700 is generally considered good. When you paid off your car loan you reduced the value of one of the five main factors used in calculating your FICO credit score – the credit mix. You were managing a car loan (an installment loan) and a credit card (a revolving credit account) successfully at the same time. So, you had two active accounts on which to base your score. Now, you are just managing one.
A healthy mix of various types of borrowing is worth about 10 percent of your overall score. By paying off your loan you turned an active loan into a closed loan. In real life this is a good thing; however, in the world of credit scoring, you just became a higher risk. Paying off the loan made that part of the mix count for less. Why? Because a closed account counts for less than an active or open one. This may sound silly, but while you were paying on the account, FICO could infer that since you were paying on time, all was well with you. Now that you’re not making payments, it’s harder for them to know if you’re having a hard time financially; therefore, more doubt and more risk. Got it?
See related: Too many new cards hurt my score. Should I cancel them?
As you pay your obligations on time each month, your score will rise. If you continue on that path, the time will come when your credit will be stronger than ever. The trick is to never, ever be late on a payment.
Whatever you decide to do, I hope you will continue to keep an eye on your credit and continue to pay off those credit cards in full each month.
Remember to keep track of your score!