Will Paying Off My Mortgage Hurt My Credit Rating?

After years and years of saving, you finally have enough money to pay off your mortgage. Yippee! You can start using that monthly mortgage payment for other things, such as investing, vacations or home repairs. 

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Before you pay off your principal balance, however, it's important to consider whether paying off your house hurts your credit score. The impact of paying off a home loan depends on your credit profile, so you may see your score increase or decrease.

Does It Help or Hurt Your Credit Score to Pay Off Your Mortgage?

So, does paying off your house hurt your credit score? It depends. Your FICO scores are based on five factors:

• Payment history
• Amount of money owed
• Length of credit history
• Credit mix
• New credit/hard inquiries

Paying off your mortgage reduces the amount of money you owe, which is a good thing. The less debt you have, the easier it is to manage your finances, especially if your other living expenses increase. 

However, you also need to consider the impact of paying off a home loan on your credit mix, which refers to the types of credit accounts you have. A strong credit mix shows lenders you have experience managing different types of credit.

If your mortgage is the only installment loan you have, paying it off changes your credit mix, which may cause your score to decrease by a few points. The good news is that even if paying off a mortgage hurts your credit slightly, the effect is usually temporary.

Additionally, your mortgage continues to have a positive effect on your credit even after you pay it off. FICO's scoring models count a paid-off mortgage toward the length of your credit history, which accounts for 15% of your score. In other words, you don't need to worry too much about whether paying off a mortgage hurts your credit.

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Is There Any Benefit to Paying Off a Mortgage Early?

Now that you know how to handle a credit score drop after mortgage payoff, here are the potential benefits of repaying your loan early.

More Wiggle Room in Your Budget

One of the biggest benefits of paying off your home loan is that you no longer have to make a monthly mortgage payment. In the United States, the median monthly mortgage payment is $1,400, so getting rid of your payment can make a big difference in your finances.

You can use the extra money to renovate your home, take a much-needed vacation, beef up your savings account or max out your retirement accounts. If you've been pinching pennies, you may also want to increase your monthly budget for groceries, clothing and other expenses.

Extra Peace of Mind

Paying off a mortgage early gives you extra peace of mind. Once you pay off your loan, there's no need to worry about missing payments or having the bank initiate foreclosure proceedings. You still need to pay your property taxes and homeowners' insurance premiums, but the lender no longer has any claim over your property.

Interest Savings

Perhaps the biggest benefit of paying off your mortgage early is the opportunity to save money on interest. When you make a payment, part of the money goes toward interest, and the other part goes toward the principal balance of the loan. The faster you pay down the principal balance, the less interest you pay. If you pay off the balance several years early, you have the potential to save thousands of dollars.

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Does Getting a Mortgage Hurt Credit Scores?

When you take out a mortgage, you may notice your score drop. The decrease occurs for two reasons. First, getting a mortgage increases the amount of debt you owe, which is one of the most important factors used to determine your credit scores. Secondly, the lender pulls your credit report, putting a hard inquiry on your credit profile. Fortunately, your score should recover if you make on-time payments and avoid opening too many new accounts.

The Bottom Line

Paying off a loan hurts your credit temporarily if you don't have any other installment loans in your credit mix. However, the potential benefits of an early payoff far outweigh the drawbacks, so try not to worry if you paid off a loan and your credit score dropped. As long as you continue to handle credit responsibly, your score should recover quickly, leaving you free to enjoy life as a homeowner without a mortgage payment.