Ironically, even though having little debt is associated with good borrowing practices, paying off loans early can hurt your credit score. Also, in some cases, keeping a debt may allow you to earn money through higher-yielding investments. However, as long as you manage debt responsibly and still use credit, any negative effect of eliminating a debt is probably negligible.
Identification
Normally, paying your debts before they are due does not hurt your credit score. Paying early usually means that you do not default on your debt and damage your credit rating with missed payments. Also, 30 percent of your FICO rating depends on your level of outstanding debt, so expediting payment on a loan increases your credit rating more than making minimum monthly payments.
When It Hurts
Paying off installment loans -- loans with a set payment schedule -- early can hurt your credit rating because the FICO system only counts active installment debt in your "mix of credit" category. In the latest FICO equation as of 2011, "mix of credit" is worth 10 percent, according to the Fair Isaac Corp. If you have a high rating -- above a 760 -- you can see a drop of up to 50 to 60 points when you have no installment debt on your credit report, according to the CreditNet website.
Keeping Accounts Active
If you want to keep your credit rating high, you need recent activity. Positive information, such as paid in full accounts, stays on your credit history for 10 years, but your past two years is the most important and best indicator of your risk. Thus, paying a mortgage off now may make it harder to acquire one in the future if you stop using credit. If you pay off a credit card and do not use for several months, the lender will report it as dormant, which hurts your credit utilization rate. For instance, holding $4,000 in credit card debt and having a $10,000 total limit gives you a utilization ratio of 40 percent. If an account with a $2,000 limit becomes inactive, your utilization ratio goes up to 50 percent.
Considerations
If you have credit card debt, you should pay it off and keep the account active by putting a small charge on it each month and paying that off, too. For loans with a low interest rate, such as a mortgage, pay off your higher-interest debts first, such as credit cards and auto loans. You may want to keep debt when you can use savings to invest in a more profitable vehicle. For example, it is more profitable to put $10,000 in a bond that returns 10 percent each year than putting the money toward a mortgage with a 5 percent interest rate. The presence of certain accounts associated with high interest rates, such as finance accounts, always hurt your credit rating, according to Experian.
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