Paying off a loan can hurt your credit score

By David Myers | Columnist

Q. My uncle passed away earlier this year and left his house to me. I recently sold the property and made a profit of about $77,000, which is almost enough to pay off the mortgage on my own home. If I pay my own loan off in a lump sum, will it raise my overall credit score?

A. Paying your loan off would certainly relieve you of a major monthly expense, but it probably won’t raise your credit score. In fact, it could actually lower it.

Most banks and other creditors check a consumer’s FICO score when determining whether a loan or other type of account should be approved or denied. The FICO scoring system was developed a few decades ago by California-based Fair Isaac Corp., and it’s designed to help lenders gauge an applicant’s future credit risk.

Therein lies the rub. An installment loan that you pay monthly, whether it’s a mortgage or a car payment, gradually increases your credit score because your prompt payments demonstrate that you are a reliable borrower. But if you pay the loan off in a lump sum, you’ll no longer have a credit-building account - and your FICO score may drop.

As my kids might say, “That’s kinda goofy, huh?” And I would agree.

• For a copy of the booklet “Straight Talk About Living Trusts,” send $4 and a self-addressed, stamped envelope to David Myers/Trust, P.O. Box 2960, Culver City CA 90231-2960

© 2008, Cowles Syndicate Inc.

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