Reader question: Does repaying a loan hurt your credit score?

Last week, on my review of Kristin Wong's new book Get Money!, a reader named Luke left an interesting comment. Luke wondered:

One thing that I've taken to heart is debt reduction. In my case, student loans. I refinanced a while back to get a lower rate and have been paying almost triple the monthly minimum to accelerate payoff. The goal was to finish the loan payments a few months before we buy our first home (which we are currently in the middle of saving for our 20% down).

But I've encountered a sort of catch-22. As the individual loans get rolled off when they get paid, it's been hurting my credit score because my average age of credit is dropping. (I'm 27 years old.) This is exactly what I don't need before applying for a mortgage.

I'm wondering if I should slow down my loans repayments to keep my credit score high when I apply for a mortgage, which will probably be in a year or two.

This question is outside my area of expertise. As you all know by now, I'm good at the Big Picture stuff, at addressing issues of mindset and behavior. But when it comes to nitty-gritty details of personal finance, I have to ask the experts, just like you would.

In this case, my go-to credit expert is the awesome Liz Weston, a NerdWallet columnist and author of Your Credit Score. I dropped her a line to ask about Luke's situation, and she wrote back with some advice. Everything that follows in the next section was written by Weston..

Does Repaying a Loan Hurt Your Credit Score?

Paying off an installment loan early typically does not hurt your credit scores. But it also doesn't help your scores as much as keeping the account open and active (that is, paying the loan down on schedule).

Luke gave us a clue to the problem when he referred to his credit “score”. We don't have one score. We have many. He may be looking at scores from different sources with different formulas and assuming a trend where there isn't one. The scores may not even be on the same range.

For example, the VantageScore 3.0 we offer for free at NerdWallet is on the traditional 300-to-850 range and draws from TransUnion credit bureau data. The FICO Bankcard Score 2 that Wells Fargo offers its customers is on a 250-to-900 scale and draws from Experian. The two scores likely won't be the same. They might not even be that close.

So, if you looked from one to the other, you might think your scores were going up or down when they weren't.

If Luke is looking at the same score over time and seeing significant downward movement, it's probably due to something else. The usual culprit is high balances on credit cards. Even if you pay in full every month, the amount of credit you're using on a card has a big influence on your scores.

Bottom line: Luke shouldn't expect that paying off a loan early will help his scores, but it shouldn't be dinging them much, either.

And to switch from my credit score expert hat to my CFP hat: If qualifying for a mortgage is important, he likely would be better off banking those extra payments to boost his down payment and build a bigger emergency fund. As J.D. will tell you, homeownership is expensive!

What Would You Do?

I agree with Liz: While getting out of debt is important, Luke should keep the Big Picture in mind. When deciding what to do next, he should consider not only his current goals, but also his future goals. (It sounds like this is what he's trying to do, and that's a good thing.)

Debt sucks. Trust me, I know. But once you've shifted your financial momentum and have begun to develop good habits, it doesn't hurt to carry a bit of debt (gasp!) if doing so allows you to meet larger goals. (Honestly, I wish I could take out a mortgage for my house. No joke. But because I have limited income, that's not an option.)

I think Liz is right. While Luke should definitely work to pay down his student loans, he might want to consider prioritizing the eventual home purchase. It's likely he can find a balance that allows him to work toward both goals.

What do you think? What would you do if you were in Luke's situation? Would you prioritize debt repayment or would you concentrate on saving for a home? Have you ever noticed how repaying a loan affects your credit score?

More about...Credit

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John
John
2 years ago

Closed accounts still factor into your average credit age. It’s only when a closed account ages off past 10 years that it impacts your average age (and might impact your credit score). Since Luke is only 27, I doubt any of his closed accounts have aged off his credit report yet. In my experience, credit age is a very SMALL percentage of your overall credit score. According to CreditKarma/FreeCreditScore/Citi/Chase/etc sites, I have an average credit age of about 3.5 years because I churn CC offers (usually 4-6 a year for their bonuses). I have over 8 inquiries on each of… Read more »

Kiryn
Kiryn
2 years ago
Reply to  John

I’ve never had a score above 800, and usually the only negative mark against me is the age of my credit. I’ve been sitting at about 3 years with all other stats being perfect (don’t have any debt except credit cards I pay off every month), but it feels like the only way to get my score any higher is to just sit on my credit cards for years without applying for anything new. I’ll apply for another from time to time due to finding something with a better bonus, and I’ve got several sitting around with nothing on them… Read more »

Mouse
Mouse
2 years ago
Reply to  Kiryn

There’s not a lot of difference between 750 and 800 — I wouldn’t sweat it too much.

Jason@WinningPersonalFinance
2 years ago

It’s hard to say what I’d do without knowing Luke’s interest rates on the debt. If they are high (>6%) I’d pay them right away even if it delayed purchasing a home for a few months. If they are low (<4%) I'd pay them slowly and invest the difference into a down payment fund, emergency fund or retirement savings. In the middle is a bit of a grey area depending on personal preference. One thing is for sure. I would NOT worry about paying off the debt hurting my credit score. If the credit score is not in the excellent… Read more »

Gabe
Gabe
2 years ago

I was in this position a few years ago, and paying off my loan definitely lowered my credit score (at least according to one of the free pseudo-score sites). Because of how old it was and some more recent credit cards being opened, it shifted my average age of credit quite significantly. I don’t remember the exact point change, but it changed from “low excellent” to “high good” or thereabouts. I wasn’t about to buy a home or any other event where my credit would particularly matter, so I was happy to have the debt gone (and over time the… Read more »

First Step
First Step
2 years ago

A mortgage broker can provide a better recommendation based on the type of loan Luke wants for his purchase. Talk to multiple brokers and loan officers to determine a good fit. This is just as important as having a good real estate agent. Underwriting requirements have gotten crazy, and depending on Luke’s debt ratios, he may need to pay off the loans before closing, plus have documentation from the lender confirming the payoffs. A good broker loves prepared buyers and will be happy to talk to Luke months before he’s ready to apply for a loan. He/she will provide guidance… Read more »

Joe
Joe
2 years ago

That’s a complicated equation. If it was me, I’d pay off the student loan first. It’s easier to deal with one thing at a time. I think it’s not that difficult to get a mortgage these days. That’s just me, though. Good luck!

Ella
Ella
2 years ago

JD, can you please explain “Honestly, I wish I could take out a mortgage for my house. No joke.” What are the larger goals you might be shooting for (in the previous sentence above) that would be worth the added risk and mental overhead of a mortgage? I’m struggling to understand this trade-off.

jp
jp
2 years ago
Reply to  J.D. Roth

I go back and forth on this, it seems like, on an almost daily basis. We have 2 paid off properties (previous homes we lived in, paid off, moved and turned into rentals), and then our current home (we have a mortgage at 3.25%, will eventually turn into a rental). Some days I want to plow all extra money at the current mortgage so it’s gone, and other days, I want to re-fi/cash out the other 2 properties to invest in more. For the moment, I’m just going to sit tight, save the extra money for down payment on house… Read more »

Tom Murin
Tom Murin
2 years ago
Reply to  J.D. Roth

JD, you are talking about leverage. You’d have a better ROE if you had the mortgage. Tax benefits too. However, I like the idea of not having a mortgage though. You’re a free man because of it (h/t to Harry Browne). Otherwise, I think the folks that worry about credit scores here generally shouldn’t. The difference in their scores is not going to make a difference in qualifying for a mortgage or result in a different interest rate. I’ve had a roughly 800 score for most of my adult life. While I’ve qualified for some favorable rates – I think… Read more »

JoDi
JoDi
2 years ago

Not a comment on this article directly – just a request. Now that we can no longer get notifications by email when each article is posted, can you please include links to all of the week’s articles in your Friday newsletter instead of just a selection?

DB
DB
2 years ago

What would I do? Pay off the student loans before thinking about a house purchase. Not only would I not want two large debt payments to worry about, but as we all know, houses are expensive to maintain – much more than you can ever plan for.

Luke is only 27. My recommendation to him would be focus on eliminating the student loan debt by age 30 (the earlier the better) and then starting saving like crazy (allocate the money previously used to pay the student loan plus all possible additional funds) for a good down payment on a home.

dh
dh
2 years ago

To me, this is a really easy one. You don’t want a mortgage, period. Rent until you can buy a place outright. Debt is slavery, and if you live your life debt-free, then a credit score is a non-issue. I’m basically giving the exact advice Dave Ramsey would give, which I think is the right answer.

Bethany
Bethany
2 years ago

Case study 1: My husband and I paid off our student loans several years ago and are still renting & trying to save up a down payment. Case study 2: My brother & his wife bought a house at nearly zero down while still carrying student loans. Then sold the house at a barely-break-even price to move for a new job, and shortly afterwards paid off their student loans… and now they are renting & saving up for an actual down payment. Moral of the stories? You’ll probably end up in about the same place either way. So just do… Read more »

Lady Dividend
Lady Dividend
2 years ago

Hmm. I never thought about the fact that when you make your last payment and a debt closes, your score can be affected. I think at this time I’ll pay that on schedule and put my extra payments on my mortgage and LOC where they can do more ‘dama ‘ in becoming debt free.

S.G.
S.G.
2 years ago

There are too many variables, in both a credit score and a budget to give a straight recommendation. The formula for credit scores is convoluted and proprietary, partially so people can’t game them (though people still try). Paying off a debt for one person is going to have a different effect than fot another. And whether a student loan should be paid off before buying a house also depends on a number of factors: balance, payment, income, house prices in the area, etc. It’s also personal. I didnt pay off my student loan before buying a house. The rate was… Read more »

Luke
Luke
2 years ago

The amount of feedback here is amazing! Thanks to everyone who weighed-in. It seems there are good arguments for both paying off the debt or maintaining some of it, but it sounds like I should start to think about speaking with a loan officer to understand how my credit simply factors in – since the mortgage loan size and rate is a larger and more complex equation than just the score (of which – I don’t even yet know which one they’ll be looking at). Either way, I feel more confident in handling the situation, whichever way I go with… Read more »

lmoot
lmoot
2 years ago

It wouldn’t affect average age of credit…not for several years anyhow…and by then your current credit will be aging (provided you don’t add too many new accounts), which might make it a non issue. There are other factors that might have caused the drop. It could be a temporary thing with your other accounts if certain things haven’t been reported or updated yet, or it could be a decrease in account variety, which has a minimal impact on your score. It could also be a reduction in credit availability, causing your utilization to go down. This can be remedied by… Read more »

lmoot
lmoot
2 years ago
Reply to  lmoot

Credit utilization to go UP, not down.

Jennifer
Jennifer
2 years ago

I never had student loans, but always had good credit, so I’m not sure how much paying off that kind of debt would hurt your chances at a decent home loan. Your debt-to-income ratio and down payment would probably be more important to lenders and home sellers (in a competitive market). I have to object to a few comments about paying off the mortgage. We currently live in the upper flat of our duplex, so after 10 years, we pretty much have someone else paying the mortgage, but there is always upkeep and property taxes, so there’s no “free rent”,… Read more »

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