One of the most common questions that I receive has to do with what would be the best thing to payoff to improve someone’s FICO score. Judging by the frequency of the question and the overall surprise of the answer I thought it would be a good “FICO Score pop quiz” question, so here you go!
Which of the following would improve your FICO score the most?
A. Paying off a $2,000 Collection
B. Paying off a $30,000 Auto Loan
C. Paying off a $300,000 Mortgage loan
D. Paying off a $7,000 Credit Card
Before you answer there are a few ground rules to this quiz. First, the starting score is a 620. This is important for a few reasons but mainly because this is a score that needs improvement.Second, the payoffs of the accounts are a payment in full, not a short sale or settlement and everything else on the credit report remains the same.OK, good luck!
Using a scoring tool built by FICO here are the results…
Paying off the collection account in this case actually decreased the FICO score!
Your FICO score is more concerned with the incident when it comes to collections not the balance.People get this idea that if they pay off their collection accounts that it is going to magically improve their FICO score. Reality is, doing this will have a slightly positive to neutral effect on your score.However things can go wrong, most commonly if dates get updated on the account it can appear as if it’s a new collection which will cause a negative impact to the score! Talk about great motivation to pay off a collection!
Paying off the auto loan had a 5 point improvement
Balances or lack of balances on installment debts are not that important to the score and this simulation provides more proof.A lot of banks that want to “help” their customers improve their FICO score sell them on this idea of having the customer give the bank $1,000 to put into a CD and then using that as collateral on a $1,000 installment loan.They usually tell the customer that by doing this they will get a new installment loan on their report which will be great for their credit score.Keep in mind this is not an interest free loan by any means.I know their motives are only to “help” the consumer improve their credit rating but this approach is not the best answer!
Paying off the mortgage had a 5 point improvement
Guess what, a mortgage loan is just another installment loan!This helps to squash the Myth that the larger the balance, the more it hurts your score idea.Pay off your mortgage to save money on the interest if you want too but don’t get caught up in the idea that this is a credit building tool.
Paying off the credit card improved the score by 35 points!
Credit card debt is considered more risky than installment debt because usually installment debts are secured by some asset.This is the reason that revolving accounts (credit cards) play a much bigger role in the score.In this simulation we paid off one revolving account all together as well as lowered our overall “utilization” to less than 10 percent, both of which are great for our FICO score.
These results are simulated, but prove that when it comes to paying off debt to improve your FICO score use it on credit cards.