Don’t pay off your loan! This might sound a little off or even just bad advice, maybe even advice your parents would yell at you for, but maybe you should consider not paying off your loan. Or at least strategically think about doing so.
Hear me out. I’m currently in the process of buying a house (or at least trying to). This has been a goal of mine for a while and since then I’m at that point where I could possibly qualify (for another post).
But of course being a first time home buyer and not knowing much of what to expect, I wanted all my ducks in a row ready to bounce on any deal I can find. I wanted everything to be perfect so everything can run smoothly and I can try to qualify for the most I can.
So of course the biggest factor to one buying a house is your debt to income ratio. I think this is like the pinnacle of home affordability because banks want to see how much money you’re making or taking in vs. how much money is going out.
At the time I did have loans, two in fact. I had two personal loans, I forget what for, but just know that I have two. They were 5 year loans for roughly about $5000.00 each. Me being me, I personally like longer financing and lower monthly payments (yes interest will be high, but its a personal preference). Anyways, these loans weren’t remotely going to be closing anytime soon. They were probably at their half way mark or 2 years left of its original 5 year loan term. At this point in time, the total combined balance of both loans were roughly $6000.00, with a monthly obligation of approximately $550/m. Not bad.
But still. AGAIN, I wanted this to be perfect and to be able to have my best chance in qualifying for a house. So here’s smart me thinking, “okay, let me pay off these loans so I show that I don’t have monthly obligations”. And I did have the cash to pay off the loans because I was saving, so the next thing I did was I paid off the loans.
BIG MISTAKE
A few days after paying off the loans, essentially closing them, my credit score tanked. I went from 740 to 700. That’s a 40pt drop. And let me tell you, that 40pt move makes a difference in terms of the rate you’re going to be offered on your loan. Your debt to income will determine how much house you can afford, and your credit score will determine what rate the bank will give you.
It didn’t even cross my mind that this would happen. But when it happened, I realized why. When you pay off your loan/account, it essentially closes on your report. Depending on how long your loan/account has been established, you essentially delete the history of the loan, affecting your credit age. So keep that in mind. Your average credit age will be affected once you close down an account, especially with loans with long terms.
So in my end, I basically wiped out 3-5 years of good credit history in the span of a few days. I’m entirely positive my score will go up again in the near future, but at the time I did things and processed my pre-qualification, it wasn’t such a smart idea to do what I did.
If you were in a similar situation where you want to lower your debt to income ratio but also don’t want to drop your credit age, you can pay a lump sum paying 95-97% of what you owe on your loan. That way you still maintain your loan/accounts history while maintaining a low overall balance. At least this is what I would do next time. But if you’re not in this situation where you’ll be needing financing for anything, by all means. Pay off your debt and enjoy being debt free 🙂