Logically, paying off your loans should raise your credit score since you’re showing that you pay back money you owe someone. Sadly, it’s not that simple. The effect that paying off a loan has on your credit score depends on a variety of factors. Let’s dive deep on what we know for sure and what we can only guess about.
Lowering your credit utilization raises your credit score.
Credit utilization is the amount of money you’ve spent divided by the total amount of money you could borrow. So for a credit card, it’s how much you owe your credit card company at any point in time divided by your credit limit. A credit utilization above 30% has a negative impact on your credit score. By paying off your credit card, you’ll lower your credit utilization which can have a positive effect on your credit score.
A solid track record.
When you make payments on time and pay off a loan in full, it can positively impact your credit history and credit score. This shows lenders that you are a responsible borrower and can be trusted to repay debt. However, paying off a loan alone may not necessarily increase your credit score significantly unless you have a limited credit history. But having less debt to your name and a good track record is beneficial even if it doesn’t boost your credit score immediately.
Lower debt-to-income ratio
Lenders often look at how much debt you have to your name relative to your income. This could be an annual figure or a monthly calculation of what your monthly debt payments are versus your monthly income. Paying off loans will lower your debt-to-income ratio which is a good thing in the mind of lenders. If you are planning to make a big purchase, like a house, in the near future and plan to finance it using a mortgage, it could be helpful to lower your debt-to-income ratio to get the best rate possible.
Paying off loans saves you money(!)
Setting aside all of the credit score effects, paying off a loan saves you money! You’re paying less interest over the life of the loan which is money you could be putting toward other purchases. That alone is reason enough for some people to pay off their loans.
Jury says - maybe guilty, maybe innocent
It’s really hard to know if paying off a loan will improve your credit score, so do what’s best for you and your personal financial situation.
Peach out ✌️
