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Paying off your student loans is undoubtedly a reason to celebrate. For some, it's an accomplishment that can take decades to achieve. But don't expect a big jump in your credit scores after sending in your final payment.
Like with any installment loan, paying off a student loan generally doesn't have a major impact on your credit scores. It might even temporarily drop your scores, although a small decrease isn't necessarily a reason for concern.
What Happens When You Pay Off Your Student Loans?
When you pay off a student loan, the account will be closed and appear on your credit reports as "paid" or "paid in full" with an account balance of zero.
If you never missed a payment, or you missed a payment and then brought the account current before paying off your student loan, the account will remain on your credit reports for 10 years after you pay off the loan. However, the late payments get deleted from the account's history seven years after they occurred.
If you were behind on your payments and then pay off your loan, the entire account will be removed seven years after the first missed payment that led to your delinquent status.
Whatever the timeline, the account can continue to affect your scores as long as it's on your credit reports.
Paying off the loan in full is generally good for your credit history, as it shows you've followed through on the loan agreement. However, when you first pay off your student loan, there might not be a change in your scores or there may be a small increase after you make your final on-time payments.
Sometimes, paying off a student loan can lead to a drop in your credit scores if your remaining open accounts have high balances or if you no longer have any open installment accounts. That's because having a mix of open installment and revolving accounts could be good for your scores, and having high balances on all your open accounts might hurt your scores.
Don't worry, though. If there is a drop in your scores, it's generally a small decrease. Scores also tend to recover within a few months as long as there isn't any new potentially negative information added to your credit reports, such as a late payment, high credit card balance or hard inquiry.
Continuing to make on-time payments on your other loans or credit cards, and keeping your credit card balances low, can also help you improve your credit scores in the future.
Paying Off Student Loans Could Lead to Better Financial Health
No matter the immediate impact on your credit scores, paying off a student loan can increase your overall financial health.
You may want to celebrate at first, and use the money that you would have sent to your student loan servicer on a special night out. After that, decide how you want to put your money to work:
- Build your emergency fund. If you don't already have an emergency fund, building up at least $1,000 in savings (and ideally enough savings to cover three to six months' worth of expenses) can give you an important safety net. You can use the money to cover one-off emergencies, such as a broken down car, or for ongoing expenses if you lose your job or get hurt.
- Pay off other debts. After building at least a small cash cushion, you can start aggressively attacking any high interest debts you have, such as payday loans, credit card balances and any other accounts with double-digit interest rates.
Paying off these debts can save you money that you would have otherwise spent on interest, and you can once again put the money you free up toward building savings or paying down other debts.
As an added incentive, carrying low credit card balances can help improve your credit scores because it reduces your credit utilization ratio, or the amount of credit you're utilizing vs. your total credit limits. Plus, each loan you pay off lowers your overall monthly payment amounts, which can increase your debt-to-income (DTI) ratio. Many lenders consider your DTI when you apply for a new account.
- Save for important financial and personal goals. You may have other goals that will require saving, such as buying a new car, purchasing a home, financing a wedding or contributing to a child's education fund.
- Spend as you please. Even if you haven't tackled all your financial goals, you may want to split the extra funds between needs and wants.
Less Debt Means More Options
Paying off your student loans might not lead to a big change in your credit scores, but it can have a significant impact on your life. There is the financial benefit of making fewer loan payments and the mental relief of no longer having to worry about the loan. It's certainly a win-win and an achievement you should celebrate.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.