Can Having Less Debt Lower Your Credit Score?

Question

Background:

In preparation to buy my first house I've started keeping an eye on my (Experian FICO) credit score, and I've been seeing behavior that is very strange. After a year of my credit score only going up each month, in the last two months it has dropped somewhat substantially. While two months ago it was at 711, a month later it was 698, and this month it is 678. The only reports in that time have been my auto loan paid in full (which actually happened in March and just took a while to report), and my credit card limit went up (I use 0 - 10% my limit and pay it top of every month). All my accounts have exceptional history except for my student loans because I missed my first few payments post-college. I have no collection accounts and no bankruptcies and these drops happened before a recent credit inquiry for a mortgage pre-approval so that didn't cause these drops.

I can only guess that either:

1. It is dropping because I haven't put anything on my credit card these last couple months (I use it for gas but haven't been driving much), or
2. Perhaps it's actually because that auto loan account was closed and ongoing payments are no longer being reported. Though I would think that would have a neutral effect, not a negative one.
3. My final guess is that maybe current economic factors are playing a role.

Can anyone knowledgable on this subject make a statement, or educated presumption on what could be causing these drops to my credit score?

TLDR:

1. Can paying a loan in full or closing an account hurt your credit score just due to the fact that you are making less ongoing payments, even though that is only because you don't owe anyone anything?

2. Can hits to the economy such as Covid-19 affect your FICO score even if you haven't been missing payments?

Answer 1

Paying off the car loan could have a small impact. 10% of your score is based on credit mix and if you only have a credit card, that could lower your score. The auto loan would be considered an installment loan and was adding some diversity to your credit portfolio, but your student loan(s) should fit into that category as well. If you are still paying on at least one student loan, that probably isn't the cause. The other reason paying off one loan can lower your score is because it can effectively increase your utilization ratio. This article from Experian explains how paying off a car loan can hurt your score. It specifically addresses paying off the loan early, but some of the points also apply to paying it off on time.

The current pandemic by itself should not be impacting your credit score. This article from Experian shows that average debt is trending down and credit scores are trending up. Only changes in behavior as a result of the pandemic should have an impact on your score.

Answer 2

Can paying a loan in full or closing an account hurt your credit score just due to the fact that you are making less ongoing payments, even though that is only because you don't owe anyone anything?

For you, the answer is "it doesn't matter", more on this later.

In my case no, after paying off all my debt I know have a far higher score now then I had while I things like car payments or a mortgage.

Can hits to the economy such as Covid-19 affect your FICO score even if you haven't been missing payments?

No. A FICO score is about your own interaction with debt and it is very personalized. They continue to get better at predicting your ability to pay.

For your first house, a score of 625 or more will qualify you for the best rates. So minor changes in the score do not matter. More important factors are income, down payment, debt-to-income ratio, and past collections. Since you don't have past due collections you don't have to get those cleaned up.

If your credit score is 825 and you try to buy a home that costs 500K, 20% down payment, and a 30K/year income you will be turned down. If we change the credit score to 650, and the income to 125K/year the person will be approved ad the best possible rates.

Minor changes in credit score can be ignored. You are doing a good job of concentrating on what is important. Paying off your other loans in preparation for buying a home. If it was me, I would retire the student loans and any other consumer debt before buying.