When Paying Off Your Student Loans Can Hurt Your Credit Score
If you’re among the millions of Americans carrying student loan debt, you may be wondering if paying off that debt as soon as possible should be your plan. Here’s what you need to know about how paying off student loan debt could temporarily hurt your credit score — even though you will likely benefit in the long run.
How your student loans can hurt your credit score
Although it might seem hard to believe, paying off your student loans completely can negatively impact your credit score, at least temporarily. Paying off a student loan could decrease your credit score for a few different reasons:
Your student loan account is marked as closed. It is generally considered good for your score to have some established and open credit accounts, which could be loans or credit lines. Thus, closing an account could temporarily hurt your credit score.
Your credit mix could be impacted. Part of how credit scores are determined is by analyzing your different types of credit. Wiping out a student loan could affect your credit mix, so it might bring down your score.
For example, student loans fall under the umbrella of installment loans. This means a fixed sum of money is borrowed and then repaid on a set schedule. Revolving credit accounts, such as credit cards, provide access to a credit limit set by a lender. Consumers determine how much of that credit limit they use and then pay it back on a monthly basis, with interest if carrying a balance.
But if you don’t have a mix of credit types, such as installment loans and revolving credit, don’t panic: Credit mix only accounts for about 10% of your FICO® credit score.
The length of your credit history may also shorten. Part of your credit score is based on how long you have had loan accounts open. If you don’t have much credit history outside of your student loan, closing the account could shorten your credit history, which can lead to a lower credit score.
Even though your credit score may be decreased as a direct result of paying off your student loan debt, rest assured the impact is temporary and you should ultimately benefit in the long run by paying down any sort of debt, student loans included. Paying loans on time and staying well within your credit limit will help you have a good credit score.
How to keep your credit score high
To minimize the impact on your credit score while paying down your student loan debt, you can do the following:
Keep other credit accounts open. If you have other accounts, such as store credit cards or consumer credit cards, for example, you can keep those open during the time period of paying down your student loan debt in order to keep a good credit mix.
Don’t max out your credit lines. Although it can be helpful to keep other accounts open, it isn’t helpful if you will be maxing those accounts out. If, for instance, you run the maximum balance on a credit card or multiple cards, it could hurt your score. A significant part of your credit score is based on your credit utilization rate, which is the percentage of your total available credit you’re using.
Experts recommend keeping your utilization rate below 30%, and closer to 10% if you expect to get the most favorable terms from lenders.
So, if you come close to maxing out your credit cards, your utilization ratio will be high because you’re using almost all of your available credit, and that can lower your credit score. Notably, your utilization rate does not include installment loans like mortgages, auto loans and student debt, so paying off your student loan won’t affect this tally.
Make all your payments on time. Paying your bills late can significantly impact your credit score, so make sure that you make any scheduled student loan payments on time before paying the loan off completely. The same applies to any other bills you may have, such as cellphone payments, rent, mortgage or utilities. Even one late payment can lower your credit score and payment history makes up about 35% of your FICO credit score, so timely payments are very important.
Avoid finance company loans. Under some credit scoring models, loans from finance companies may negatively impact your credit score. Unlike traditional banks or credit unions, finance companies don’t take deposits and are only in the business of making loans. Finance companies include auto dealer financing arms, as well as organizations that offer “payday loans” and other products rife with fees and steep interest rates.
Understand that your credit score can vary. The three main credit bureaus may have slightly different data included on your credit reports. That said, your scores based on these reports should be in the same general range. If one of your scores is dramatically different, get copies of your credit reports and look for errors, which you can dispute with the bureau in question.
What to do after paying off your student loans
As you get ready to pay off your student loans, make sure you are educated on the ins and outs of student debt. For instance, LendingTree’s student loan education center could help you find answers to your questions.
After paying off your student loan debt, you can focus on ways to rebuild your credit score. To help raise your score and stay in a good financial situation, consider the following steps:
Recognize the benefits of paying off your debt. Paying off your student loans is a positive financial step, despite the potential temporary drop in credit score. Not only does paying off debt feel great, but it can free up your finances. It can also lower your overall debt, which may benefit your credit score.
Put extra money toward savings. Remember that loan payment you were making every month, with a lot of it going to interest? You can now work on paying yourself first instead of the government or a lender. Continue making that same “payment” amount directly into your savings to build up your emergency savings account.
Check your credit score. You won’t know how your credit score has actually been affected by paying off your loans until you check it, right? You can find out using LendingTree’s free credit score tool and even get help trying to improve your score if it is less-than-ideal.
Get help when you need it. If your credit is in need of more assistance, you might consider seeking help from a nonprofit credit counselor or a reputable credit repair company to help get your finances back on track. LendingTree may connect you with a credit repair service to help you with action items like disputing fraudulent items on your credit history.
The bottom line
Student loan debt might be one of the best kinds of debt you have. The terms are generally good, with low interest rates and generous payback times. And of course, you can get an education as a result of your debt that will hopefully lead to a more financially stable future.
And although you may be reluctant to pay off your student loans, you should know that even if it temporarily reduces your credit score, paying down student loan debt is a positive step. Paying back loans on time is important for your credit, and without those loan payments, you can save money on interest. With more money potentially in your pocket and positive information in your credit history, you may also be more eligible to qualify for different types of loans, such as a mortgage or business loan.
So, congratulate yourself on making the smart moves of getting an education and paying off your debt because both are investments in your future.