How Paying off Loans Affect FICO Score

Your FICO score is a three-digit number that ranges from 300 to 850 and is used to assess your creditworthiness. This score is based on several factors, including your payment history, credit utilization, length of credit history, types of credit, and new credit. One factor that can significantly impact your FICO score is paying off loans. In this article, we will explore how paying off loans affects your FICO score.

Types of loans

Before we dive into how paying off loans can affect your FICO score, it is essential to understand the different types of loans that exist. The two main types of loans are revolving credit and installment credit.

Revolving credit: Revolving credit is a type of credit that does not have a fixed term. It allows you to borrow up to a certain amount and repay it over time. Credit cards and lines of credit are examples of revolving credit.

Installment credit: Installment credit is a type of credit that has a fixed repayment term. You borrow a specific amount of money, and you repay it in fixed installments over time. Mortgages, auto loans, and personal loans are examples of installment credit.

How paying off loans affects your FICO score

Now that we have a better understanding of the different types of loans let’s explore how paying off loans can affect your FICO score.

Payment history: Your payment history accounts for 35% of your FICO score, making it the most critical factor. Paying off your loans on time can have a positive impact on your FICO score, as it shows that you are responsible and reliable when it comes to repaying your debts. However, if you have missed payments in the past, paying off your loans will not erase those missed payments from your credit report. It can take up to seven years for missed payments to drop off your credit report.

Credit utilization: Credit utilization accounts for 30% of your FICO score. It is the amount of credit you are using compared to the amount of credit available to you. Paying off revolving credit loans, such as credit cards, can lower your credit utilization ratio and improve your FICO score. However, paying off installment loans, such as auto loans or mortgages, does not impact your credit utilization ratio.

Length of credit history: The length of your credit history accounts for 15% of your FICO score. If you pay off an installment loan, such as an auto loan or a mortgage, it can shorten your credit history, which can have a negative impact on your FICO score. This is because a longer credit history is more favorable to lenders as it shows that you have a track record of responsibly managing credit.

Types of credit: The types of credit you have accounts for 10% of your FICO score. Having a mix of revolving credit and installment credit can be beneficial to your FICO score. Paying off loans can impact your credit mix, so it is important to consider this factor when deciding which loans to pay off first.

New credit: The amount of new credit you have accounts for 10% of your FICO score. When you pay off a loan, it can lower the amount of new credit you have, which can have a negative impact on your FICO score. This is because lenders want to see that you have a healthy mix of old and new credit and are not taking on too much new credit at once.

In summary, paying off loans can have a positive or negative impact on your FICO score, depending on the type of loan and your overall credit history. Paying off revolving credit loans can lower your credit utilization ratio and improve your FICO score. However, paying off installment loans can shorten your credit history and impact your credit mix, which can have a negative impact on your FICO score