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Paying off your student loans is good news for your financial health. Although it's possible your credit score will see a minor dip right after you pay off a student loan, your score should ultimately recover and may even rise. In either case, these early effects don't account for the long-term benefits of paying off student loan debt. Paying off a student loan frees up more of your monthly income and gives you the opportunity to set and reach new financial goals.
What Happens to Your Credit After Paying Off Student Loans?
To understand how paying off a student loan might affect your credit, it may help to consider how student loans can impact your credit throughout their lifecycle.
Student loans appear on your credit report as installment loans. These are loans that have a set dollar amount and a predetermined number of monthly payments, similar to a car loan. Adding an installment loan to any revolving credit card accounts you may have can improve your credit "mix," or types of credit you manage, which is a factor in calculating your credit score.
When you begin repaying your loan, your payments are reported to the credit bureaus. As long as your payments are on time, they contribute positively to your payment history—and, in turn, to your credit score. Late payments, collections or defaults also appear in your credit history and have a negative effect on your score. By the time you make that final loan payment, much of your student loan's credit story has already been written during the years you've been managing and repaying this debt.
So what happens when you pay off your loan? Paying off the loan in full looks good on your credit history, but it may not have a dramatic impact on your credit score.
When you make your final loan payment, the account status on your credit report will be updated to "paid" (insert massive sigh of relief here). You may see a temporary dip in your score from the change to your credit report, especially if your student loan was your only installment loan or if your remaining loans or credit cards have high balances. You may also see a small increase after making your last on-time payment. Or you may also see no change at all. There is no set rule for how a final loan payment will affect your credit score—but in most cases, any effect is usually temporary.
If your score decreased after your last student loan payment, it will likely bounce back within a few months as long as there are no other negative issues in your credit history and you continue to make all your other debt payments on time. Your positive payment history on the account will remain part of your credit report for up to 10 years and will thus have some positive impact on your credit for years to come. If you had any negative items—late payments or collections, for example—these will stay on your credit report for seven years from the date of the original delinquency, at which point they will drop off.
The Benefits of Paying Off Your Student Loans as Soon as You Can
Paying off student loan debt can affect much more than your credit score. By removing the financial and emotional weight of student loan debt, you are free to reimagine your finances. You can:
- Pay off high-interest credit cards. You'll save money on interest and reduce your monthly debt load even further.
- Save up for a house. Funnel the money you used for monthly student loan payments into a down payment fund. Or upgrade to a nicer rental.
- Qualify for a car loan or mortgage. Not only can you save more toward a down payment, but you may also qualify for a larger loan now that you have a more favorable debt-to-income ratio (DTI). Lenders consider DTI to determine whether you can safely take on a new monthly loan payment.
- Create an emergency fund. If you haven't already, be sure to set aside emergency-only savings so you won't have to borrow money if you find yourself in a difficult position.
- Treat yourself. Go on vacation. Take yourself out to dinner. Buy yourself a computer. Invest in your own side hustle. As long as you're not putting yourself into a difficult financial position, celebrate your achievement.
Eliminating student debt makes financial goals more attainable. And here's a final note on financial health: With less debt to manage, it may be easier to manage your debt—that means making all of your monthly payments on time, keeping your credit utilization low, monitoring your credit consistently, and avoiding unnecessary applications for new credit.
How to Pay Off Your Student Loans Faster
If life after student loans sounds appealing—but you still have a ways to go—consider forming a strategy for paying off your student loans faster. Here are a few ideas to get you started:
- Start paying back your loan early. Your student loan may not require you to begin repayment until six months after graduation, but you can begin paying while you're still in school and reduce the principal amount you owe.
- Pay more than the minimum each month. Adding even $50 or $100 to your monthly payment can chip away at your loan term significantly. Or throw in a lump sum when you receive a financial windfall—a tax refund or work bonus, for instance—to lower your principal.
- Consider consolidating or refinancing your loans. If you have multiple federal student loans, you may be able to consolidate them into a single fixed-rate direct consolidation loan. If you have good credit and you're open to private student loans, you may be able to lower your interest rate and/or shorten your remaining loan term by refinancing your student loan on the private market. Keep in mind that you'll lose the benefits federal student loans offer, so weigh the pros and cons before refinancing.
A Milestone to Celebrate
Making your final student loan payment probably won't be a seismic event for your credit score, but it is a milestone to celebrate. It marks a dividing line between one phase of your life and another. In the first phase, hopefully you repaid your loan responsibly and used it to help build good credit over time. In this next phase, you can make new choices on how to spend and save your money, track and improve your credit, and reach new financial goals. Good news, indeed.