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Although you could save money each month by not having to pay for your car, doing so could lower your credit score.
Thats because open accounts showing a good record of on-time payments have a powerful effect on your score. Closing an account also may reduce your credit mix and average age of accounts.
Heres what to know about how paying off a car loan early may affect your credit score.
The short answer is: it depends While paying off your car loan early might seem like a responsible financial move, it can actually lead to a slight decrease in your credit score in the short term
This might seem counterintuitive, but there’s a logical explanation behind it. Here’s a breakdown of what you need to know:
Why Paying Off Your Car Loan Early Might Hurt Your Credit Score
1. It Shortens Your Credit History:
Your credit history is a major factor in your credit score, and it accounts for 15% of your FICO® Score. The longer your credit history, the better. When you pay off your car loan early, you’re essentially shortening your credit history, which can have a negative impact on your score.
2 It Reduces Your Credit Mix:
Your credit mix refers to the different types of credit you have, such as installment loans (like car loans), revolving credit (like credit cards), and mortgages. Having a diverse credit mix shows lenders that you can manage different types of credit responsibly, which is a positive factor in your credit score. Paying off your car loan reduces your credit mix, which could potentially lower your score
3. It Lowers Your Credit Utilization Ratio:
Your credit utilization ratio is the amount of credit you’re using compared to your total available credit. This ratio accounts for 30% of your FICO® Score. When you pay off your car loan, you’re lowering your total debt, which can improve your credit utilization ratio. However, if you don’t have other forms of credit to offset the decrease in debt, your credit utilization ratio could actually increase, which would negatively impact your score.
When Paying Off Your Car Loan Early Might NOT Hurt Your Credit Score
1. If You Have a High Credit Score:
If you already have a high credit score (above 760), the impact of paying off your car loan early will likely be minimal. Your score is already strong, so a small decrease won’t have a significant impact.
2. If You Have Other Forms of Credit:
If you have other forms of credit, such as credit cards or a mortgage, the impact of paying off your car loan will be less noticeable. Your other credit accounts will help to offset the loss of your car loan and maintain your credit mix and utilization ratio.
3. If You Have a High Interest Rate:
Even if it temporarily lowers your credit score, paying off your car loan early can save you money if it has a high interest rate. The interest savings could outweigh the potential negative impact on your score.
What You Can Do to Minimize the Impact on Your Credit Score
1. Keep Your Other Credit Accounts Open and Active:
Even if you don’t use your other credit accounts frequently, make sure to keep them open and active. This will help to maintain your credit history and credit mix.
2. Pay Your Bills on Time:
This is the most important factor in maintaining a good credit score. Make sure to pay all your bills on time, every time.
3. Keep Your Credit Utilization Ratio Low:
Aim to keep your credit utilization ratio below 30%. This means using less than 30% of your available credit on your credit cards.
4. Consider Opening a Secured Credit Card:
If you don’t have a lot of credit history, consider opening a secured credit card. This is a type of credit card that requires a security deposit, which reduces the risk for the lender. Secured credit cards can help you build credit history and improve your credit score.
The Bottom Line
While paying off your car loan early might have a small negative impact on your credit score in the short term, it’s important to remember that your credit score is constantly changing. As long as you’re practicing responsible credit habits, your score will eventually recover.
Ultimately, the decision of whether or not to pay off your car loan early is a personal one. Weigh the potential benefits and drawbacks carefully before making a decision.
How do I decide whether to pay it off early?
You might want to pay off your car loan early if you have the funds to do so, especially if your interest rate is high. Before you commit your money, consider your position on other financial objectives, such as maintaining an emergency fund. And think about whether your car loan qualifies as good or bad debt.
You might be able to refinance your auto loan and save money if you’re worried about a high interest rate but don’t want to spend the money to pay off your loan. When refinancing, try not to extend the loan term unless your circumstances have changed and the previous payment has become unmanageable. Extending the loan will almost certainly increase the amount of interest you pay.
Your car loan’s impact on your credit score
It helps to understand how credit scores work — they’re all about how you manage borrowed money. Continuing to make on-time payments helps build your payment history, which has the biggest influence on credit scores. Closing the account means its no longer actively contributing to your payment history.
An installment account, or one with a predetermined term and a fixed monthly payment, is what an auto loan is. If you don’t have any other installment accounts after your loan is paid back, you risk losing points because your credit score is also influenced by your “credit mix.” ” The average age of your open accounts may also affect your score. Those with a long history of making their credit card and installment loan payments on time receive the highest scores.
Therefore, paying off your auto loan, or paying it off early, may actually cause your credit score to slightly decline.
Will Paying Off My Car Early Tank My Credit Score?
FAQ
Will my credit score go down if I pay off my car?
Is it bad to pay off car loan early?
Can paying off a loan early hurt your credit?
Does paying a car loan build credit?
Does paying off a car loan early hurt your credit score?
Paying off your car loan early will hurt your credit score, but only in the short term because having an open credit account that you regularly make payments on has a greater positive impact on your credit score overall. However, there are other factors to consider as well. Here’s what you need to know.
What happens if you pay off a car loan early?
Paying off a car loan early can cause a slight dip in your credit scores, depending on your credit profile. Any dip is likely to be temporary as long as you’re practicing responsible credit habits with other accounts. Paying off a car loan early can affect credit-scoring factors such as credit history, credit mix and total debt.
Should you pay off a car loan if you have a credit card?
In other words, if you have a car loan and a few credit cards, paying off your car loan eliminates the only installment debt you had, thereby reducing your credit mix.
Does a paid-off car loan affect your credit score?
So as long as you were always on time with your payments, the loan will continue to have a positive effect on your credit history. However, even though the paid-off car loan will ultimately help your credit score, having more opened positive-credit accounts has a greater impact than closed ones.