For many people, a home mortgage is the single-largest debt on their credit report. It seems logical, then, that paying off your mortgage in full will improve your credit score. However, your credit score derives from a complex algorithm that takes many factors into account. Paying off your mortgage has no direct effect on your score but can affect some things that make it easier to get approved for other financing.
How Your Credit Score Works
The three major credit reporting bureaus calculate your credit score based on an amalgam of details about your credit history. The main factors that go into this number include your payment history, level of outstanding debt, the age of the credit accounts you have currently, the type of debt you carry and the length of your personal credit history. Paying off your mortgage, or any other particular debt, may affect your level of debt -- but plays little role in the other considerations.
Debt-to-Income Ratio
The percentage of your monthly income that goes to making payments on your debt is a chief factor in getting approved for new loans. Since your house payment often represents a large percentage of your monthly expenses, paying off your mortgage can instantly improve your debt-to-income ratio a great deal. Although this is not technically part of your credit score, it is a way that paying off your mortgage will improve your credit situation.
Home Equity Credit
Another way paying off your mortgage can instantly improve your credit situation is through the equity in your home. If you own your home free and clear, you have equity -- often hundreds of thousands of dollars in equity -- that you can use to secure a loan at low interest. This gives you ready access to credit on good terms, credit that regular payments on will improve your credit score over time.
Adverse Action
If your mortgage account has gone delinquent or into default, the reports of this on your credit record can drastically reduce your credit. In this case, paying off your mortgage can have an immediate effect on your credit record by marking the adverse actions as resolved. However, the actions will remain on your record for up to seven years and continue to have a negative effect on your score throughout that time.
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