This was written by Olivia Kendall, a client happiness team lead at Earnest.
I just paid off all of my student loans — and my FICO took a huge, 40-point hit! What gives? I thought paying down my debt as quickly as possible (while still contributing regularly to an emergency fund) was the responsible thing to do? Shouldn’t my score go UP by 40 points when I prove I’m a low credit risk by paying my loans in full, earlier than expected?
Sleepless in San Francisco
Congratulations on paying off your student loans. No matter what’s happened to your FICO score, that’s a huge accomplishment and your move will free up more of your income to do things like invest, save, or treat yourself.
The TL;DR answer to “Shouldn’t my score go up when I pay off my loans?” is: Not necessarily. Here’s why.
When you pay off a loan and then close the related account, it can impact your FICO score in a couple of ways. (A quick refresher on your FICO score: The formula to calculate this number has multiple factors, including credit utilization, the length of credit history, and credit mix.)
First, when you close a revolving account (like a credit card) it can affect your credit utilization ratio or the amount of revolving debt you have relative to the available credit you have. If you close an unused $0 balance credit card, your utilization ratio will increase. And that could negatively impact your FICO score.
Next, the closure of an account could zap the repayment history associated with that account. A long history of on-time repayment helps build your credit—but if you close that account, there goes its history with it. That could also negatively impact your score.
Third, when you close your student loan accounts, which are considered installment loans, and have only revolving credit remaining (like your credit card) or no other credit at all remaining—your credit mix will change. This could also negatively affect your FICO score.
The more credit history you have, the less your FICO will be impacted by singular events like closing an account.
Learn more: How to Read Your Credit Report
If your FICO score did take a hit, and you’re looking to build it back up as fast as you can, you might think using a credit card in a responsible way as a way to boost it. The best way to accomplish this is to always pay off your balance in full each month, and keep the account open even if you’re not using it every month.
Showing that you can sensibly manage both installment debt (like student loan or auto loan) and revolving (like a credit card) is a factor in your overall score. This can help with improving your credit mix. If your credit file is relatively thin (i.e., if there are not a lot of items in it either because you are new to credit or you don’t utilize it as part of your financial strategy) then credit mix is even more important.
Going forward, know that showing lenders that you’re both predictable and responsible is sometimes more advantageous than just showing that you’re responsible, at least from the perspective of FICO scoring.
Lastly, one more thing to be prepared for when closing an account is the potential for fees. In the world of lending companies, whenever a borrower pays off their loan before the term is due, it’s considered a “prepayment.” One reason many traditional lenders don’t like prepayment is that it makes it harder to track and manage loans. In fact, many traditional lenders discourage people from doing this by imposing an additional fee if they pay off their loan early. (Note: Earnest never charges fees for extra payments or paying off a loan.)
What are the best things you can do to ensure your credit score improves over time? Be attentive, ask questions, and make sure you truly understand the terms of any new loan or line of credit.
Special thanks to John Davidson, an underwriter at Earnest, for his contributions to this piece.