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.