(DailyFix.org) – Whether it’s good or bad, credit scores are part of life if you intend to acquire a mortgage, purchase a vehicle, or apply for a credit card. For millions of young Americans, student loans were unavoidable. There’s over $1.5 trillion in outstanding student loan debt in America, and odds are you’re carrying school debt. Many look forward to the day when they no longer have to make that high monthly payment.
Like any form of credit, school loan providers report payment histories to the three major credit reporting agencies, which can help or hinder your credit score. It comes down to a few basic things. Student loans are generally considered installment loans. Like mortgages or auto loans, in the beginning, when the balance is high, it slightly impacts your credit score negatively. As you pay it as agreed upon over time, it helps improve your score. Still, what if you pay off your student loans?
Will that help improve your credit rating?
How Does Paying Your Student Loan Impact Your Credit Score?
Installment loans such as student loans have a fixed interest rate and a consistent monthly payment. Your credit score reflects your management of revolving lines of credit, such as credit cards. Keeping revolving lines of credit low and paying your bill on time is the best way to maintain a healthy credit score. Still, installment loans help build a credit history and are an important component of your credit mix.
A credit mix doesn’t just include installment loans or revolving debts. It also factors in the age of your credit history. For example, the older an active installment loan is, the better it impacts your credit score. The age of a student loan factors into your credit mix. Also, the fewer the number of new accounts you have, the higher your score. The more you pay on an old account in good standing, the better benefit it is to your credit score.
Paying Off Your Student Loan Could Temporarily Set Your Score Back Slightly
Installment loans like student loans help your credit score by offering a mix of credit types and demonstrating one’s ability to meet their financial obligations. For many young adults, a student loan is their only installment loan. One would think paying off a debt would merit a reward. Well, that’s not necessarily the case.
When your loan provider reports your loan as paid in full to the credit reporting companies, you could lose some credit diversity on your report. That could cause your credit score to drop temporarily.
What’s important to remember is your credit report will recover quickly so long as you pay your other debts on time. Many people get so caught up in the credit score they fail to realize a credit score is designed to help people reach financial goals and save money. There isn’t a better way to put money back in your bank account than by paying off your loan. Plus, it reduces your credit to income ratio. That could make it easier for you to purchase a home or car after paying off your debt.
It’s also important to remember a credit score is a tool. Not all financiers look at a score the same way. Besides, your credit score will change over time as you use credit, develop habits, and manage your debt well.
So, if you plan to pay off that student loan in the near future… Congratulations!