Handling a variety of loans in a responsible way can help your credit score.
But if you lose certain lines of credit, it can make a negative impact as well.
What happens when you close out a mortgage or an auto loan? Will it make your credit score decline, and if so, is there anything you can do about it?
That’s what a listener of the Clark Howard Podcast recently asked.
Will My Credit Score Tank When I Pay Off My Mortgage or Auto Loan?
Will my credit score drop when I pay off a loan?
That’s what a Clark listener wanted to know on the April 18 podcast episode.
Asked Tony in Wisconsin: “Clark, years back when I paid off my mortgage, my credit score went down quite a bit (mid 700s to mid 600s). I currently have two primary credit cards that I pay off monthly and one auto loan. My Credit Karma score is 825. My auto loan will be paid off in a couple of months.
“Will my credit score go down again when I pay off my car? If so, would opening another credit card at this time help? Any thoughts or suggestions?”
Fortunately, your credit score is not going to drop 100 points just because you close out a loan. But the Fair Isaac Corporation (FICO) and the co-op of the three major credit bureaus called VantageScore can more confidently give you a high mark if they’ve got more data points.
So it is possible for your credit score to go down when you close out one of those types of loans.
“They all look for multiple types of credit. Because they find they have a more complete picture if you have a mortgage, you have a car loan, you have a home improvement loan, you’ve got credit cards, whatever,” Clark says.
“You have no mortgage anymore and soon you’re going to have no car payment. This is a success tax. They don’t have as much deep data to go by. And that’s why their scoring models get confused. And may lower your score some when all you have is credit cards.”
Credit Cards Only? You Can Still Have a Strong Credit Score
There’s good news for Tony and for anyone reading this who may be spooked by the thought of paying off your mortgage or auto loan.
In the absence of other lines of credit, managing your credit cards properly is crucial to your credit score. That starts with holding at least two credit cards, which is one of Clark’s favorite rules.
Credit cards are the only lines of credit that Clark holds, which has been the case for many years.
“But I have no problem with my credit score at all. Because as long as you know how to manipulate that score when you’re credit cards only, you’ll be absolutely fine,” Clark says.
“Now what do I mean by manipulation? The second-most important factor in your credit score is how much of your available credit you’re using. That’s roughly one-third of what makes up your credit score.
“So if you keep what’s known as your utilization down around 10% or less, your credit score will be absolutely fine even having no other lines of credit.”
Understanding Credit Utilization
Credit utilization is crucial if credit cards are the only ongoing data points to calculate your score.
You also may not realize that there’s a difference between paying your credit card balance in full every billing cycle to avoid interest and the balance that may get reported to the bureaus calculating your score.
“It’s the balance on your closing date [that gets reported],” Clark says. “Now if you pay it in full, you pay no interest. But you are still showing a balance [to the credit bureaus].
“So that’s why people who don’t have any outstanding mortgage, don’t have any other credit at all other than cards, you want to have a lot of available credit. Because that’s what sends your credit score way back up.”
If you’re paying off a loan, whether it’s a personal loan, a mortgage or an auto loan, congratulations.
Interest rates have soared since January 2022 as the Fed raises bank rates. And you’re no longer having to sacrifice your hard-earned money to service that debt.
No matter how many types of debt you have, it’s a great idea to try to keep credit card debt to a minimum. Your credit score — and your overall financial health — will thank you.