Did You Know: The influence of installment debt on your credit scores

Date: May 29, 2018

“I just sold my house and paid off almost $340,000 in mortgage debt by doing so. My credit score was almost unchanged after. Why wouldn’t it improve considerably by getting out of so much debt?”

This is actually a pretty common question, and it sheds light on a topic that is not often covered, which is the value and influence of installment debt on your credit scores. Many believe all debts are created equal, and thus have equal impact on your credit scores. This is untrue.

First off, what is an installment debt? Installment debt is a loan where the debtor has fixed payments for a fixed number of months. For example, an auto loan is an installment loan. Your lender might require 48 monthly payments (or monthly “installments”) of $350 in order to pay off your car loan. Mortgage loans, home equity, student, personal, boat and motorcycle loans are common examples of other installment loans.

Installment loans are often reported to the credit reporting agencies, so they will show up on your credit reports. And credit scoring models consider them when calculating your credit score. So back to the original question: Why wasn’t there a considerable improvement in the credit score once the installment debt was paid off?

Installment loans are very different as risk predictors from other types of debt, like credit card debt. Installment loans tend to be more stable over time because they are typically secured by an asset that the debtor does not want repossessed or foreclosed upon. This is known as the loan’s “collateral.”

If you stop making your auto loan payments, you’ll eventually have your automobile repossessed. Consumers generally do not want cars, boats or other items repossessed, so they tend to make payments on time even when funds are tight.

Because installment debt tends to be more stable over time, its initial influence on your credit scores is modest. And that’s the reason paying it off doesn’t typically result in a large score improvement: It never lowered the score much to begin with. You can easily have VantageScore credit scores well above 700, even with hundreds of thousands of dollars of installment debt. In fact, Prime consumers typically carry $100,000 to $105,000 in total debt.

When it comes to installment loans, it’s almost better to refocus your attention on how well you’re managing the payments rather than the actual balance. The fact that you’re making payments on time on your installment loans is considerably more important than the loan’s balance. The payment history of the account is considered to be of extreme importance.

Having said that, it is true that as you pay down your installment debt, your score should improve, albeit slowly and slightly. It is a fact that a lower installment loan balance relative to the original loan amount is good for your credit score. Keep in mind, however, that it can take years of payments for your installment balances, especially on mortgages, to be considerably lower than the original loan amount. This is because most installment loans experience balance reduction much more slowly because they can be amortized over many years or decades. As such, early on in the life of your loan the balance is going to be very close to your loan amount. Still, by making your payments faithfully each month, you will also be ensuring that your credit scores are as high as they can be.

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