Paying off student loan can hurt credit score

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Q. I have a question about my student loans. I have three remaining, and I’m almost done paying one off. Because the interest accrues on the loans daily, should I close the account once it is paid to avoid interest accrual or can I close it without it affecting my credit score?
— Getting there

A. Congrats on making progress on paying off your loans!

Here’s the skinny on what it all means for your credit score.

You might expect that erasing one of your loans would improve your credit score: Less debt = better score.

However, the formulas for calculating your score are more complex and surprisingly, you might actually see a dip in your score after closing your loan account, said Cynthia Aiken, a certified financial planner with RegentAtlantic in Morristown.

How could that be?

Well, 10 percent of your credit score is associated with the credit mix that you have, Aiken said.

“Student loan debt is considered installment debt and is different than credit card debt,” she said. “Having a mix of types of debt can enhance your credit score and if you eliminate your installment debt, then the credit mix will change unless you have a car loan or mortgage.”

If the mix is reduced, then your score may drop slightly, she said.

Aiken said although you might be disappointed to see your score dip, you still should go ahead and pay off your student loan. Less debt lowers you debt-to-income ratio, which is another measure the credit rating companies consider, she said.

Plus, it frees up extra cash.

In your particular case, you have two other outstanding student loans, so you may not see a drop in your score at the close of the first loan, Aiken said.

“It is difficult to predict what will happen to your score once all your loans are paid off because of the many factors which go into calculating your score,” she said. “However, paid off and closed accounts can continue to be part of your credit history for years and can support your positive payment history.”

In fact, she said, paying off all the loans is an important demonstration of your ability to make on-time payments and to manage your finances and will be helpful when you want to apply for new credit accounts.

“In the final analysis, you should go ahead and pay off the first loan and continue to pay down the other two loans without concern for a slight dip in your credit score,” Aiken said. “Your strong history of on-time payments will ultimately support your credit score.”

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NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.