Will Paying Off my Student Loans Affect My Credit Score?
With the student loan pause set to end in 2023, interest will begin accruing on federal student loans. Many of the borrowers we speak with question if they should pay their loan down/off during this period. Perhaps you are one of the borrowers who are hopeful targeted student debt relief will proceed, and you will see all or a portion of your student loan forgiven. With these conversations often comes the question of how paying off student loans may impact a credit score.
Paying off debt is a good thing. It is true that paying off your student loans could minimally reduce your credit score in the short term, but, remember, your credit score is only one small part of your financial health and you will likely see your score rebound quickly. The long-term gains of paying down/off your student loans will prove more beneficial for your future financial success than any short-term decline in your Fair Isaac Corporation (FICO) score.
How does paying off my student loans affect my credit?
Paying off student loans can have a mixed result on your credit, but you might see a short-term fall in your FICO credit score. Student loans are installment loans, like a car loan or a mortgage. Installment loans have a balance that is paid over time with a fixed payment amount monthly. Lenders view paying down an installment loan favorably, especially if paid on time. While paying off a student loan will decrease your debt-to-income ratio, a plus for lenders, paying off this loan will also show your account as closed. The on-time payment history you have accumulated on that closed account will no longer show on your credit report, potentially reducing your credit score. As long as your other credit accounts are used responsibly (paid on time and in good standing), however, this decline in your FICO score will be temporary and you will likely see your score bounce back quickly.
What are the positives of paying off my student loans?
Paying off your student loans will free up cash flow and allow you to focus on other financial goals:
- Pay off higher interest debt/credit cards: You will save money on interest and further reduce your monthly debt.
- Saving for a home or car: Saving for a down payment will mean less borrowing on future purchases. You will qualify to borrow a larger loan amount with a smaller debt-to-income ratio.
- Creating an emergency fund: If you have not already done so, create an emergency fund to protect yourself in the case of a financial emergency. This will keep you from having to borrow funds or use credit cards if an emergency arises.
- Fun Money: Consider setting aside extra funds for vacations, dinners out, or the occasional item you might want to buy without using a credit card and increasing debt.
