Federal student loans are a common source of financing for people who otherwise can't afford to pay for their undergraduate and graduate educations. These loans are often the first credit accounts these individuals get, providing them with opportunities to begin building a solid credit history that will lead to credit card offers, mortgages and car loans down the road. The key to building this solid credit history is to make your payments on time throughout the life of the loan. Another factor in this equation is the impact to your credit score when the loan is finally paid off.
Understanding the Account Type
Like mortgages and car loans, federal student loans are classified as “installment loans.” These installment loans carry much less weight on your credit report than credit cards, as the loan is gradually paid off without risk of either accumulating additional debt or obtaining an increase in your credit limit. This differs from revolving credit accounts, which can be maxed out when used irresponsibly or extended to provide a borrower with more spending power.
Paying off a federal student loan early will not hurt your credit score, even though your lender might not be happy about losing the interest income it would normally get if you stuck to the original payment plan. Similarly, paying a loan off early has no impact on how the length of the loan is reported on your credit report. A five-year loan is still reported as a five-year loan even if you pay it off in less than five years.
A Slight Dip
Although it’s unlikely to affect your credit score too much, you may notice your scores fall slightly after paying off your federal student loans if you don’t have any other open installment accounts. One factor that affects your credit is the diversity of the accounts you have open at any one time, which should ideally include a mix of installment and revolving credit. More important than that, however, is how you manage the credit you do have. To keep your scores as high as possible, make it a point to pay bills on time, keep revolving balances low and otherwise manage credit wisely.
The advantage to paying off your federal student loans is that you’ll be decreasing your debt-to-income ratio – a very important factor that lenders consider when approving credit card and loan applications. This factor won’t be reflected in your credit score, but will improve your overall creditworthiness in the eyes of lenders.
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