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?

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