10

I am looking to buy a house within the next year or two.

My issue is that I have a little under $2k in student loans. I could pay that off at any time and the interest is barely $2 per month.

I have been told that paying off student loans can close the account, and therefore be harmful to my credit score.

If I plan to buy a house at this time next year, my student loans will have been paid off and the account therefore closed. Would that negatively affect my credit score to the degree that it could harm my mortgage prospects or even result in a higher interest rate? Would it even be worth changing my payback plan to stretch the student debt timeline out by a year or so, so that I could retain the higher credit score before applying for a mortgage?

  • 19
    Pay off the loans, best thing for your financial future. – Pete B. Jul 13 '17 at 15:59
  • Do you have any other debts (credit cards, cars)? – D Stanley Jul 13 '17 at 16:30
  • 2
    If you just want to keep an account open, apply for a couple of credit card and never use them. It doesn't make much sense to keep a loan going and accumulating interest for the sake of a credit score. – Jay Jul 13 '17 at 17:25
  • you might be able to pay it down to 200$ or even 2$. then you're only on the hook for pennies a month in interest. some student loan programs allow you to stop making monthly payments if you are ahead of schedule. you could check the repayment rules on your account. – james turner Jul 13 '17 at 19:30
  • 3
    Silly suggestions like this are part of a whole collection of credit score voodoo, encouraged by companies which sell services related to credit score optimization. If you have a bad credit score which restricts your access to sensible credit, you need to improve it. If there is an inaccuracy in your credit score which has a significant negative effect, you should have it corrected. No one else needs to spend a lot of time optimizing their credit score, let alone make significant financial decisions based on what the outcome for their credit score will be. – jwg Jul 14 '17 at 10:27
12

I'm going to dissent from the other answers and suggest you keep it open... for now. If the interest is barely $2 a month as you say, and you plan on making your house purchase this time next year, you're looking at maybe $25 to keep the account.

I recently moved house and used some of the proceeds to pay off my only auto loan. I'm also not on the mortgage on my new house. So my only type of credit now is revolving credit cards, which I pay off each month. Immediately following the closure of my mortgage and auto loan accounts, I saw a dip on my FICO credit score of about 25 points. I don't need more credit right now, so it's not a big deal to me. However, that is the sort of bump that could see you drop out of lender's "Prime" bracket into the next tier down (depending on your current score). The result of a drop like that could mean being offered a slightly less favorable interest rate. When we're talking about large, long term debts, that could easily result in more than $25 extra interest per month, in the early years of the loan.

My experience is of course anecdotal, so you might not experience the same kind of drop. But is it worth risking for a $25 saving now? I would suggest you keep the loan account open until you've bought your house. Then immediately pay it off, since you won't need to play the stupid credit score "game" any more (at least not for several years).

  • 5
    +1. I fully agree with you. One of the few times it matters in your life to have the best credit score possible is when purchasing a big ticket item such as a home. A slightly better interest rate on a mortgage can save thousands. See my "Interesting Side Note" at the end of this answer where I put this into action: money.stackexchange.com/a/77630/17718 – TTT Jul 13 '17 at 17:40
  • Your FICO score, or your VantageScore? Vantage will dip a bit, as they only consider open accounts, but FICO won't dip because of closing an account. 25 points though are entirely possibly due to any number of other reasons, mine varies by more than that on a week to week basis... – Joe Jul 13 '17 at 18:10
  • 5
    "the best credit score possible" Actually anything over 740 is considered "excellent" so scrambling to go from 760 to 780 does nothing. – D Stanley Jul 13 '17 at 18:52
  • 4
    On the other hand, moving from 720 to 740 could be quite beneficial. – CactusCake Jul 13 '17 at 18:53
  • 1
    @Joe, I think the idea, though, is why risk a change at all over $25. I think along the lines of "don't open a CC when you're shopping for a mortgage," It's never really clear where a lender will pull your credit information from, it might be FICO, it might be a proprietary score from one of the bureaus, and $25 just isn't much against even a single basis point of mortgage interest. – quid Jul 13 '17 at 20:37
7

It's likely not going to make a significant difference either way. The biggest factors to your mortgage are going to be a reliable income, your debt/income ratio (smaller is better), and the loan-to-value ratio (smaller is better). So long as you're not stretching your income too much, the student loan isn't going to be a huge factor.

In addition, paying of a loan account is different that closing a revolving credit account (credit card). Closing a revolving account increases your utilization (how much you've borrowed versus the total of all credit limits), which is what hurts your credit score. Closing a loan account does not impact your utilization, but does reduce your total amount borrowed, which should improve your score.

If there are some negative factors from closing out the debt (which I doubt there are), they will likely be offset by the reduced debt-to-income ratio. You'll be better off saving as much as you possibly can for a 20% down payment, which will determine how much house you can afford to buy. Having 20% down will also save you a lot in your monthly payment, since you won't have to pay mortgage insurance (PMI)

All that aside, debt is not a game. Don't play around trying to improve a score that you have no control over. Remember that these scores are partially supported by banks and credit card companies that make money when you pay interest, so they obviously want to encourage yo to borrow more. Don't borrow money that you can't pay back very quickly for anything other than a house, and make sure you pay your bills on time. Then your credit score won't matter. Your income won't be sucked away by debt payments, and you can invest, build wealth, and not worry about your credit score,.

7

In the short term, closing this account will have zero effect on your credit score, beyond lowering your utilization slightly.

It will not have any impact on the 15% "Average Age of Accounts". Yes, the "o" stands for "of", not "Open" (it would be Capitalized if it were). This is easy to find articles about; see Mint, CreditCards.com, etc. FICO does not care if it's open or closed now, just when it was first opened; it will eventually fall off your report in 7-10 years after closing, but that's not anywhere close to the timeframe you're talking about.

It will also not impact the credit mix, in the short term. See MyFico.com for example (again, this is not hard to find in a search). FICO considers all accounts, open or not, so long as they're still on the credit report (7-10 years).

Pay off your loan, or don't, based on your financial situation. Don't consider your credit score in this, as it won't impact it at all.

  • 1
    I didn't downvote your answer, but your answer seems only relevant to FICO, which is not the only scoring used. – Hart CO Jul 13 '17 at 20:34
  • 1
    @HartCO it's pretty much the only one used in the mortgage industry. – iheanyi Jul 13 '17 at 21:51
  • Why is this so low scoring? It addresses the key point missed by the other answers--you get the beneficial effects for 7 years after the month you close it. – Loren Pechtel Jul 14 '17 at 0:09
4

Any scheme that has you choosing to pay more interest for the sake of your credit score is fundamentally flawed. Yes, credit score can dip slightly after closing out an installment account, but keeping it open is unlikely to benefit you. Your history of on-time payments and debt to income ratio will be much larger factors.

In my view, if you just make on-time payments you don't need to worry about boosting your credit score at all. Maybe get on with a bank that monitors your credit to be aware of fraud, but otherwise, don't fuss over your credit score.

  • No, the credit score will not dip slightly after closing an installment account. – Joe Jul 13 '17 at 18:04
  • @Joe I think you're mistaken, I see lots of results similar to this one: ficoforums.myfico.com/t5/Understanding-FICO-Scoring/… and Equifax seems to indicate an open installment loan is better than a closed one: blog.equifax.com/credit/… Maybe FICO 9 is different in that regard than FICO 8, but it's not the only scoring being used, so not safe to say that it will not dip. I said it can, not that it will, because that seems supported by evidence. – Hart CO Jul 13 '17 at 18:44
  • Then how do you explain this? myfico.com/credit-education/types-of-credit – Joe Jul 13 '17 at 20:26
  • That's current FICO scoring, was it always like that? I'm not sure, but it doesn't matter because FICO is not the only scoring being used, didn't you comment above that vantagescore would decrease? – Hart CO Jul 13 '17 at 20:33
  • I've never seen anything suggesting it was different. But either way that link doesn't prove much; it says it helps your score in general, but of course having payment history is generally beneficial. If you have other loans (credit cards etc.) that will be fine, one account doesn't matter that much for that. Vantage is different yes, but nearly nobody uses it. – Joe Jul 14 '17 at 2:23
2

The impact from closing the account is relative to the average age of your open accounts. If all of your other accounts are new and these loans are old, there will be a very slight drop in your credit score. Additionally a student loan appears as an installment loan on your credit report. If you don't have a car loan, it will effect your credit mix, but that is not going to be a big hit on your credit score. If all of your accounts are old and you have a car loan, the impact would be insignificant.

The accounts will remain in your credit history for 7 years, so you will still have the benefit of a good payment history until that time has passed. If you are planning to buy a home in a year, the best thing you can do is to focus on your down payment and make sure your debt to income ratio is very low at the time you apply for the mortgage.

  • It's not just age of accounts, if this is the only line of credit of it's type, it will also cause credit to dip, as credit mix makes up ~10% of credit score. – Hart CO Jul 13 '17 at 16:50
  • @HartCO - 10% of the score, but a change on an item that is weighted to 10% will still be very small. It's unlikely to affect the ability to obtain a mortgage. – NL - Apologize to Monica Jul 13 '17 at 17:13
  • Agreed, nice edit. – Hart CO Jul 13 '17 at 17:24
  • Both factors (AAoA and Credit Mix) consider closed accounts equally with open accounts. Closing it has no short term impact. – Joe Jul 13 '17 at 18:04

protected by Community Aug 19 '17 at 4:58

Thank you for your interest in this question. Because it has attracted low-quality or spam answers that had to be removed, posting an answer now requires 10 reputation on this site (the association bonus does not count).

Would you like to answer one of these unanswered questions instead?

Not the answer you're looking for? Browse other questions tagged or ask your own question.