Paying off your student loans is a huge accomplishment that takes persistence and sacrifice. After making that final payment, you’d hope to be rewarded with a lifted burden, and maybe a little boost to your credit score too. After all, you just showed how responsible you can be with a significant debt obligation.
You may be surprised to learn that your score may temporarily drop a bit after paying off your student loan balance. Don’t worry. Your credit score is only one measure of your financial health, and you can usually overcome these small dips quickly. It’s important to know how your student loans can impact your credit score so you know what to expect when you get that euphoric feeling of seeing $0 on your student loan account statement.
Installment loans and your credit score
Student loans are a type of installment loan, like car loans and mortgages. Generally, when a borrower takes out a set amount of money for a specific amount of time, that’s an installment loan. These loans usually come with a fixed interest rate and consistent monthly payments. They’re different than credit cards, which are revolving credit lines. A revolving credit line means you get a credit limit and can spend up to that amount at any time. Your statement balance will vary each month depending on what you spend during that billing period.
Your credit score is based in part on how well you manage your revolving lines of credit. Keeping your credit card balances low and making payments on time are the two big factors in maintaining healthy credit. Even though installment loans may not affect your credit score as much as credit cards might, they can still help you build credit history.
Any installment loans you have can help in a category often referred to as credit mix. The impact this category has on your credit score will vary based on the scoring model used. Credit mix measures your ability to maintain a consistent payment history with multiple types of credit accounts. For many young adults, student loans may be the only installment account they have on file. So when your student loan falls off your credit report, you may lose that credit mix diversity, which can temporarily lower your score.
Remember that the point of building your credit health is to help you reach your financial goals and save you money over the long-term. By paying off that debt, you’re already saving money. To improve in the credit mix category, you need to show responsibility with different types of accounts. Should you run out and get a new car loan or mortgage just to try and improve your score? Of course not. Your credit mix will change naturally with healthy financial habits and as you’re ready for these major life milestones. Don’t get a new loan with the sole purpose of trying to increase your credit score by a few points.
Age of credit history
Your credit history tends to start around the time you’re in college, so student loans may be some of your oldest credit accounts. The average age of all your accounts factors into your score too. While credit mix looks at how you handle different types of debt, credit age focuses on how long you’ve shown responsible credit behavior. Accounts you’ve had open for a long time with no negative marks are ideal. Closing a student loan account may reduce the average age of your accounts if it was one of your oldest accounts and was in good standing. This isn’t really something you can avoid. It wouldn’t be smart to keep the account open and make payments just to try to keep your credit score from going down. The good news is that for most scoring models, credit age is one of the least impactful categories.
Over time, installment debts will fall off your credit report after the accounts close. Paying off student loans, mortgages and car loans are huge achievements. They may change your credit mix and average credit age, which can cause a slight temporary drop in your score, but you’ve taken a big step in securing a healthy financial future. That should be celebrated.