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Can Paying Off Your Student Loans Affect Your Credit Score?
When you finally pay off your student loan debt, 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 making student loan payments, they might think you’re being kind of a jerk.
No matter, it’s your time to shine. You have come a long way from your college student days, with one eye on the due date for your next paper and the other eye on income-based repayment strategies for the new loans you just took out. It’s not like there are any downsides to paying off your student loans, right? Well...
Paying off a student loan can actually hurt your FICO credit score. Now, this isn’t something that should prevent you from paying off your student debt — the benefits still far outweigh the drawbacks — but it is a slight annoyance you’ll have to face.
Here’s why paying off your student loans, whether they are private student loans or federal student loans, could actually cause your credit score to drop — but why it isn’t something to worry about.
Student loan payoffs: a slight ding to your good credit mix
Normally, when we write about factors that are important to your credit score, we focus on the two most important ones: your credit history and the amounts you owe. But when it comes to why paying off your student loans has a minor negative effect, it’s due to one of the other factors that credit bureaus track: your credit mix.
Here’s how financial educator Maggie Germano explains credit mix:
“Lenders like to see several (and varying) accounts on your report because it shows that other lenders have trusted you with credit.”
A strong credit mix will feature different types of credit, including revolving credit. This is where you borrow money against a set limit and then make payments on that amount, just as you do with a credit card; it also includes installment accounts where you borrow a chunk of money and then pay it back in regular installments. This covers a variety of installment loans, including student loans, as well as personal loans, auto loans, mortgages, etc.
When you pay off a loan or close a credit card, that account gets marked as closed on your credit report and you receive an updated credit score. So when you pay off one of your student loans, your score refreshes to reflect that you have one less installment account than you did previously.
That will likely negatively impact your credit mix, which may cause a drop in your FICO score. It’s similar to closing out an old credit card. However, since your credit mix is such a small portion of your credit score ( just 10%), the effect will be minimal.
Credit history trumps credit mix
Fortunately, your length of credit history is the most important factor, so paying off your loan balance will not have an immediate impact. According to major credit bureaus Equifax, Experian, and TransUnion, accounts that were closed in good standing with a history of on-time payments will remain on reports for a 10-year period of time.
What, were you planning on defaulting?
The truth is this: The small impact on your credit mix should not affect your student loan repayment plan at all. While it is good to be aware of the surprising effects paying off your loan amount can have on your credit file, the effect is very minimal and there is no reasonable way to avoid it. By knowing about the possibility, you will be more prepared if a credit check is in your future.
The interest rate on both federal loans and (especially) private loans is high enough that you would likely be better off paying down the loan sooner rather than later. Your credit score will take a much bigger hit from missed payments or late payments than it will from paying off your loans.
Consider the long term
When looking at different repayment options, refinancing options, or deferment possibilities, you should take your bank account into consideration before your credit mix. After all, your payment history is more important than your credit mix, and there are better strategies than carrying over a student loan balance to help your credit score.
One of the most reliable methods is proper credit card use. If you keep your credit utilization around 30% of your credit limit and make the entirety of your monthly payments rather than just paying the minimum, you will grow your credit rating without taking on interest or credit card debt.
So enjoy the celebration. Tomorrow you can go back to all your challenges that are far more significant than any credit mix.
This article was last updated November 21, 2019. It originally published October 8, 2018.