How paying off a car loan early affects your credit score
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In the short-term, paying off your car loan early will impact your credit score — usually by dropping it a few points. Over the long-term, it depends on quite a few factors, including your credit mix and payment history. With the right strategy, you can avoid a big hit to your credit and determine if paying off your car loan is the right choice.
Does paying off your car loan early hurt your credit?
Paying off your car loan early can hurt your credit score. Any time you close a credit account, your score will fall by a few points. So, while it’s normal, if you are on the edge between two categories, waiting to pay off your car loan may be a good idea if you need to maintain your score for other big purchases.
However, your credit score may improve over time. If you have a high debt-to-income (DTI) ratio, paying off a big debt like a car loan could help your credit score.
But putting your money toward other goals, like savings or high-interest debt, may be the better route. This is because auto loans tend to benefit your score overall. Cars may be depreciating assets, but building a history of on-time payments will go a long way to maintaining — and improving — your credit score.
Paying off your car loan early should only have a small negative impact on your credit score, but ultimately, it will mean you have a more limited ability to build your score over time.
4 ways paying off your auto loan early affects your credit
Your payment history, credit utilization ratio, credit history and credit mix all factor into your credit score. When you pay off your car loan early, each can be affected — so weigh the pros and cons carefully before requesting a payoff quote from your lender.
1. Payment history
Each time you make a timely payment on your car loan, a positive payment history is added to your credit report. Over time, these payments improve your credit score.
Paying off a car loan closes the account, so you will no longer be able to build a positive payment history. And while your loan remains on your credit report for up to 10 years, open accounts have a more significant effect on your credit score than closed accounts. They demonstrate how you are currently managing credit, rather than how you did in the past.
2. Credit utilization
Your credit score is based on your access to credit and how much of it you use — your credit utilization. Paying your loan down over time gradually lowers your credit utilization and could give your credit score a chance to improve.
Once your car loan account is paid off, it will no longer count toward your access to credit. This can drastically shift your credit utilization ratio, especially if you have other big debts, which will in turn lower your credit score.
3. Length of credit history
Paid off auto loans only remain on your credit history for up to ten years. It may seem like plenty of time, but once it is removed, your credit score will fall. Lenders want to see a lengthy credit history. If you stay on schedule and pay off your car loan according to your original terms, you will have well over ten years of credit history built up.
The lengthier your credit history, the better shot you have at achieving a good or excellent credit score. If you’re working towards building or repairing your credit, it is best to keep the auto loan open to build up a positive credit history. Once you close it, the countdown starts to when it will go off your credit report.
4. Credit mix
Lenders like to see a healthy mix of revolving accounts and installment accounts. Credit cards — revolving accounts — are good for managing your credit utilization, while car loans — installment accounts — are good for building the length of your credit history.
If you pay off a car loan early and it is your only installment account, your credit score could take a hit. And if you have very few accounts in general, the hit to your score could be even greater.
When to pay your car loan off early
Despite the potential negative hit to your credit score, there are still times when paying off your car loan early is a good idea.
- If you can pay off your car loan without hurting other financial goals, you should. That being said, building your emergency fund or paying off high-interest debt should take precedence.
- Lowering a high debt-to-income ratio is also a good reason to pay off your car loan early. If your DTI is close to or over 50 percent, lenders are unlikely to approve you for more loans. Paying off your car loan will lower your DTI — and make it easier to qualify for a mortgage, new auto loan or credit card.
- Finally, freeing up funds to boost your nest egg, building wealth through investments or starting a business are all good reasons to pay off your auto loan early. But if your lender assesses prepayment penalties, you will need to weigh the costs to determine if it’s a smart financial move.
The bottom line
Ultimately, paying off your car loan early can both harm and help your credit score. You should expect a small drop when you first pay off your loan. But you will need to determine if it will improve your credit score over time before committing to an early payoff.