Can Paying Off My Student Loans Hurt My Credit Score?

Michael Lux Blog, Student Loans 10 Comments

Unfortunately, the answer is yes.  Paying off your student loan, seemingly an action that would indicate your are more credit worthy, can actually lower your score.

How does this happen?

One of the factors that affect your credit score is the age of your oldest account.  The thinking behind it is that if you have a long established credit history, you are less of a risk.  This is the reason that many financial experts suggest you keep your oldest credit card account open, even if you don’t really need it.

Unfortunately, paying off a student loan has the effect of closing an account.  For many, student loans are among the very first accounts opened, which means paying it off decreases the average account age.  Because average account age and oldest account age are both considerations in your credit score, paying off an older student loan debt, can drop your score.

Is this a big deal?

It is probably more frustrating than anything.  If you are on the brink of paying off your student loan debt, it means you are sick of paying interest, and ready to get money working for you rather than against you.  This is another one of those events that makes you think, “no matter what I do, I’ll never get ahead…”

Despite the fact that this credit dip is incredibly frustrating, it is certainly no reason not to pay off your loans.  In even the most extreme circumstances, the result of paying of the debt is just a temporary drop in score… certainly not a reason to act any differently.

What if I need a high score right now… Should I wait a couple months?

Suppose you have student loans and are looking to buy a house.  On one hand, higher credit score means you can get a lower interest rate on your loan.  At this point in time, even a few points could make a difference.  On the other hand, having existing debt, such as the loan you are thinking about paying off, limits your ability to borrow.

Your best bet at dealing with this dilemma is probably to talk to your mortgage professional several months before you need to qualify for your mortgage.  In the past, if you were dealing with your local bank, such a situation probably wouldn’t have affected your decision at all.  Today, most mortgage decisions are made based upon a convoluted formula, and the better you can manipulate your numbers the better off you will be.  Your mortgage professional should be in the best position to evaluate your individual credit history in terms of deciding what is your best course of action.

  • Too much debt will prevent you from a mortgage too! I think I would be selective about paying off student debt. I would pay off the higher interest loans first. Perhaps it would minimize any negative effects.

    • I agree. If you have a ton of debt, credit score should be low on your list of financial worries. Step 1 is to get rid of the high interest stuff, the credit score will sort itself out over time.

  • I see your point, but I think it’s definitely better to close your student loan account as soon as possible. The trick maybe to get another account not long after you open your student loan account?

    • That is a great idea. When you get that first credit card, you definitely want to keep it open, even if your rarely use it. Having that account can protect you from age related credit drops.

  • squirrelers

    That’s interesting. My initial inclination would be to focus on eliminating student loan debt ASAP, nonetheless.

    • Well said. It sucks that paying off your loan may drop your credit score, but that is no reason to let the debt fester.

  • There’s a balance that is hard to predict and will depend on each person. As you pointed out, you could get hurt if the student loan aged record falls off, but you’ll benefit with having less debt on your report.

    • Exactly. 99 out of a 100 times, the logical answer is to just pay it off. it is that one time where things can be tricky.

  • Joey

    Sherpa, the only reason I see to have any credt at all is to get a better mortgage rate. What are your thoughts on attempting to get a mortgage without any credit at all? Will you still get today’s amazing rates? Thank you! I ask you this question because for many of is the student loans are the last, or most substantial loan, before getting a mortgage.