How Prepaying a Mortgage Affects Your Credit Rating

Posted on Aug 22 2015 - 5:07am by Admin

credit cardWhen you decide to prepay your mortgage, you probably feel that incredible rush that comes with sending your loan payments ahead of time, knowing that you will own your home sooner than expected. However, if you’re just prepaying in the hopes of raising your credit score, you may be disappointed to know that prepaying won’t actually accomplish this.

Prepaying and your FICO Score

Prepayment will not directly help or hurt your credit score, since the algorithm used by FICO only factors in whether you pay your bills and mortgage payments on schedule, and NOT whether you pay off your loan earlier than expected. Although paying off your loan early is a financially wise move, FICO sadly does not factor this into your credit score.

On the other hand, you may be surprised to know that prepaying can sometimes indirectly hurt your FICO score instead of helping it. Creditors want to see a steady history of repayment, and a very short mortgage period leaves you with little time to build credit. Of course, if you are also ignoring other debts in order to pay down the mortgage quicker, this is another way for your rating to suffer.

Prepaying and Penalties

In addition, mortgage experts like warn that you should also look into potential penalties. Some mortgages can fine you up to 2% or 4% of your mortgage’s remaining balance if you pay early. You should consult your mortgage company about their specific policies, though ideally, you would know these details before you signed up for the mortgage in the first place.

To Prepay or Not to Prepay?

However, just because prepaying won’t bear any significance on your credit rating does not mean that you should forgo it. It can save you thousands of dollars in interest over the mortgage period. The first thing you have to do is evaluate your financial condition before choosing to prepay your loan, since you may have overlooked something that requires your attention. For example, maybe you should focus on settling your credit card debt instead of paying your home loan earlier, as credit cards have much higher interest rates.

At the end of the day, the decision to prepay is purely circumstantial. Make sure to do the math first to figure out what the best option is.