Why Paying Off Debt Can Boost Your Credit Score
Reducing your outstanding debt lowers your credit utilisation ratio, which is one of the most significant factors in your credit score. If you're using 80% of your credit card limits and pay them down to 20%, you'll likely see a meaningful score improvement within one to two months.
Paying off debt also reduces your total monthly commitments, which helps with mortgage affordability calculations. Lenders look at your debt-to-income ratio, and the lower this is, the more they may be willing to lend you.
When Paying Off Debt Might Temporarily Lower Your Score
Surprisingly, some forms of debt repayment can cause a short-term dip in your credit score. Closing a credit card account after paying it off removes that account's available credit from your profile, which can increase your overall utilisation percentage on remaining accounts.
Similarly, paying off and closing your only credit card or loan means you no longer have active credit accounts demonstrating responsible borrowing behaviour. Lenders like to see that you can manage credit well, so having no active accounts can actually be a slight negative. The key is to keep accounts open but with low balances.
How Different Types of Debt Affect Your Score
Credit cards: Paying down credit card balances has the most immediate positive effect because it directly reduces your credit utilisation. Keep the account open to maintain your available credit limit.
Personal loans: Paying off a loan is reflected positively on your file, showing the account as 'settled'. However, if this was your only active credit account, consider keeping a credit card with a low balance to maintain some credit activity.
Overdrafts: Clearing an overdraft shows responsible financial management. Lenders view regular overdraft use as a sign of tight finances, so being overdraft-free strengthens your application.
Timing Debt Repayments Before a Mortgage Application
If you're planning to remortgage, try to pay down debt at least two to three months before applying. This gives time for the changes to be reported to credit reference agencies and reflected in your score. Credit card issuers typically report to the agencies once a month, usually around your statement date.
Prioritise paying down credit cards and overdrafts first, as these have the most visible impact on your utilisation ratio. If you're choosing between paying off debt and saving a larger deposit, speak to a mortgage broker — in some cases, the improved affordability from less debt can be more valuable than a marginally larger deposit.
Important: Your home may be repossessed if you do not keep up repayments on your mortgage. There will be a fee for mortgage advice. The actual rate available will depend on your circumstances. Think carefully before securing other debts against your home.