What Happens When You Pay off a Loan?

Paying off a loan is a great accomplishment, which can have several different effects on your credit score. Depending on your current financial situation and credit mix, paying off a loan could increase your credit score, or even lower it temporarily. It all depends on your specific financial situation. 

It would make sense that if you pay off a loan your credit score would improve. After all, paying off a loan should be considered a great financial achievement. Unfortunately, this isn’t always the case. In fact, there are instances where paying off a loan can actually lower your credit score. It’s important to remember this so that you aren’t completely taken by surprise if it happens to you. 

So what determines whether your credit score increases or decreases after you pay off a loan? There are a few factors that will play into this. One would be called your “credit mix.” Your credit mix is just how many different types of credit you’re currently using. Credit cards, personal loans, mortgages, and auto loans are all examples of types of credit. These credit products and more make up your “credit mix.” 

When determining your credit score, your credit mix accounts for 10% of your total credit score, with a more diverse mix being seen as more financially stable. This means that if you have a healthy mix of several different types of credit it can positively impact your score. That being said, if your credit mix isn’t diverse enough and you’re only using one or two types of credit, it can negatively impact your score. 

Now that you’re familiar with what a credit mix is, you can see how paying off a loan may negatively impact your credit score, at least temporarily. If the loan you pay off is an important part of your credit mix, then paying it off may make your mix less diverse. This may be seen as a negative by the credit bureaus. But if you have several other similar loans, then paying one off could improve your credit score without affecting your credit mix.