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When your auto loan is about to expire, you might consider making an early payment but are unsure if that will lower your credit score.
Early car loan repayment will lower your credit score, but only temporarily. Having an open credit account with consistent payments makes a larger positive impact on your credit score overall. However, there are other factors to consider as well. Here’s what you need to know.
The Impact of Early Car Loan Repayment on Credit Score
Paying off a car loan early can, despite what might seem counterintuitive, have a short-term negative effect on your credit score. But in the long run, it’s usually a good thing because it lowers your debt-to-income ratio and shows that you can manage your credit responsibly.
Understanding the Factors Affecting Credit Score
Your credit score is a numerical representation of your creditworthiness calculated using various factors. including:
- Payment history: This is the most significant factor, accounting for 35% of your score. Making timely payments on all your debts, including your car loan, is crucial for maintaining a good credit score.
- Amounts owed: This factor, accounting for 30% of your score, considers the total amount of debt you have compared to your available credit. Paying off your car loan reduces your debt, which can positively impact your score.
- Length of credit history: This factor, accounting for 15% of your score, considers the age of your credit accounts. A longer credit history generally indicates responsible credit management, leading to a higher score.
- Credit mix: This factor, accounting for 10% of your score, considers the variety of credit accounts you have, such as credit cards, installment loans, and mortgages. Having a diverse credit mix demonstrates your ability to manage different types of credit responsibly.
- New credit: This factor, accounting for 10% of your score, considers the number of new credit accounts you’ve opened recently. Opening too many new accounts in a short period can negatively impact your score.
Short-Term Impact of Early Car Loan Repayment
When you pay off your car loan early, you close the account, which can have the following short-term effects on your credit score:
- Reduced credit history: The closed account no longer contributes to the length of your credit history, which can lower your score slightly.
- Decreased credit mix: If the car loan was your only installment loan, closing it reduces your credit mix, which can also negatively impact your score.
Long-Term Impact of Early Car Loan Repayment
While the short-term effects of early car loan repayment may be negative, the long-term effects are generally positive:
- Improved debt-to-income ratio: Paying off your car loan reduces your total debt, which lowers your debt-to-income ratio. A lower debt-to-income ratio makes you a more attractive borrower to lenders, potentially leading to lower interest rates and better loan terms.
- Demonstrates responsible credit management: Paying off your car loan early shows lenders that you can manage your debt responsibly, which can positively impact your credit score over time.
Additional Considerations for Early Car Loan Repayment
Before deciding to pay off your car loan early, consider the following factors:
- Prepayment penalties: Some lenders may charge prepayment penalties if you pay off your loan early. Review your loan agreement to determine if this applies to you.
- Interest rate: If your car loan has a high interest rate, paying it off early can save you money on interest charges. Calculate the potential savings to determine if it’s worth it.
- Other financial goals: Consider your other financial goals, such as saving for a down payment on a house or retirement. If you have other pressing financial needs, it may be wiser to prioritize those goals before paying off your car loan early.
While paying off a car loan early may have a short-term negative impact on your credit score, the long-term effects are generally positive. It reduces your debt-to-income ratio, demonstrates responsible credit management, and can potentially save you money on interest charges. However, it’s important to consider prepayment penalties, interest rates, and other financial goals before making a decision.
Loan is almost paid off
Paying off your loan early won’t save you a lot of money on interest if you only have a few payments left. In this case, it’s better to keep the loan and benefit from the boost to your credit score.
How Paying Off Your Loan Early Impacts Your Credit
Whenever your credit history changes—such as paying off a loan—your credit score may dip slightly. This decline should only last temporarily if your credit history is free of defaults or bankruptcies, and your credit score will soon rise again.
A car loan can stay on your credit report for up to ten years after it has been paid off, according to consumer credit agency Experian. Therefore, the loan will continue to have a positive impact on your credit history provided that you have always made your payments on time.
Though paying off your auto loan will eventually raise your credit score, opening more positive credit accounts will have a bigger influence than closing ones. Lenders are more interested in your current credit situation than your past credit history.
Additionally, maintaining an open auto loan and paying your bills on time are beneficial if you want to build your credit history or raise your credit score. A car loan will strengthen your credit file and increase the variety of your credit report if you don’t have many credit accounts.
Your credit score can be raised and your appeal to lenders increased by having a variety of accounts, such as credit cards and larger loans with fixed monthly payments.
Will Paying Off My Car Early Tank My Credit Score?
FAQ
Is it good to pay off a car loan early?
Will my credit score go down if I pay off car loan?
Does paying extra on car loan help credit score?
Do you still pay interest if you pay off a loan early?
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?
When you pay off your car loan early, your debt will become smaller. This is positive for your credit history but might lower your credit score slightly because you’re no longer logging on-time monthly loan payments. Once you pay off the loan, you will no longer have positive payment history for that long-term loan.
Should you pay off a car loan first?
If your car loan’s rate is low compared to other types of debt, like credit cards, consider paying off the debt with the highest interest rate first. That way you save more on total interest owed. 3. Credit Score Drop Any time you pay off a debt, it lowers your total credit mix and open accounts, which can cause a dip in your credit score.
Should you pay off a loan early?
So, if paying off a loan makes sense for you, avoiding a brief credit score drop shouldn’t be a reason to keep the account open. Also, reducing debt will lower your debt-to-income ratio, which lenders will be glad to see if you seek out a new line of credit once the loan is paid off. What Happens to Your Credit If You Pay Off a Loan Early?