Can Paying Off Your Student Loans Hurt Your Credit Score?
Sometimes, your credit score will react to certain financial behavior in unexpected ways. What happens when you pay off your students loans is a great example.
When that day comes and you finally pay off your student loans, it will be a serious cause for celebration. You can take all that extra money that you were putting towards your loans and throw an awesome party for you and your friends! Although, if your friends are still paying off their student loans, they might think you’re being kind of a jerk.
No matter. It’s your time to shine. It’s not like there are any downsides to paying off your student loans, right? Wrong. In fact, paying off a student loan can actually hurt your credit score. Now, this isn’t something that should prevent anyone from paying off their student debt—the benefits still far outweigh the drawbacks—but it is a slight annoyance you’ll have to deal with.
Here’s why paying off your student loans could actually cause your credit score to drop …
First, a brief refresher on credit scores.
Even if you know the difference between a great credit score (generally 720 and above) from a bad credit score (below 630), you still might not understand how a credit score actually works. Don’t worry! It’s really not that complicated.
Credit scores are like a grade on how well you’ve used credit over the past seven years. They are based on information from your credit reports, which are compiled by the three major credit bureaus—Experian, TransUnion, and Equifax. The most common type of credit score is the FICO score, which is graded on a scale from 300 to 850.
Your credit score reflects how much money you’ve borrowed, what types of credit you’ve used (like loans versus credit cards), whether you pay all your bills on time, how long you’ve been borrowing for, and whether or not you’ve applied for more credit recently. All that info is fed through a semi-secret formula to produce a single three-digit number that summarizes your creditworthiness for potential lenders, landlords, etc.
One thing we do know about that semi-secret formula are the different categories of credit info. First, there’s your payment history, which makes up 35 percent of your total score, followed by your amounts owed (30 percent). Next there’s the length of your credit history (15 percent), and finally, there’s your credit mix and your recent credit inquiries, which both make up 10 percent.
It’s all about the credit mix.
Normally, when we write about the factors that are important to your credit score, we focus on, well, the two most important factors to your score: your payment history and your amounts owed. But when it comes to student loans, it’s one of the other three factors that takes center stage: your credit mix. This category tracks the different kinds of credit that you use: Namely, how many revolving accounts you have versus how many installment accounts.
Revolving accounts are things like credit cards, where you borrow money against a set credit limit and then make payments on that amount. Installment accounts, on the other hand, are your standard type of loan, where you borrow a chunk of money and then pay it back in regular installments. This covers student loans, as well as personal loans, auto loans, mortgages, etc.
In order to have a healthy credit mix, you need to have, well, a healthy credit mix! If the only debt you have is credit cards, you’re going to get dinged for that. And if the only debt you have is all tied up in installment loans, you’ll get dinged for that too!
Bye-bye student loans, hello lower credit score.
When you pay off a loan or close a credit card, that account gets marked as closed on your credit report and your credit score gets updated. So when you pay off one of your student loans, your score then gets refreshed to reflect that you have one less installment account then you did previously.
And guess what? That’s probably going to make your score go down! This is especially true if you don’t have any other outstanding installment accounts. If you don’t have a personal loan, auto loan, or a mortgage, those student loans might have been the only installment account you had open. Plus, the odds are good that you do have a credit card—or five.
That’s not all! Has anyone told you that you shouldn’t close out an old card once you’re done using it? One of the reasons you shouldn’t is that older credit accounts also help your score. Your student loans are very likely the oldest credit account you have, so paying it off will lower the average age of your accounts, which can also cause your score to drop.
Even if your score drops, you should still celebrate.
So there it is. When you finally pay off your student loans, it could hurt your credit score. How much will it cause it to drop? Well, we actually don’t know. People’s credit scores can be pretty particular to their specific financial situations, so there’s no real way of telling.
But you know what? Even if your score does drop, it’ll be worth it. So long as you’re making all your payments on time and not taking out more debt than you can handle (pro tip: never let your outstanding credit card balances exceed 30 percent of your total credit limit), you’ll be just fine in the long run. Enjoy putting all that extra money towards more rewarding stuff.
To learn more about how credit scores work, check out these related posts from OppLoans:
- What’s the Quickest Way to Fix Bad Credit?
- Do You Still Need to Manage Your Credit Score as a Senior?
- How Bad Credit Can Affect Your Utilities
- It’s True: Bad Credit Can Mean Paying More for Car Insurance
The information contained herein is provided for free and is to be used for educational and informational purposes only. We are not a credit repair organization as defined under federal or state law and we do not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit. Articles provided in connection with this blog are general in nature, provided for informational purposes only and are not a substitute for individualized professional advice. We make no representation that we will improve or attempt to improve your credit record, history, or rating through the use of the resources provided through the OppLoans blog.