Paying off debt early is generally a good thing. That includes car loans. But itâs worth understanding how paying off debt earlier than planned might affect your credit.
It may seem backward, but paying off a car loan early could hurt your credit. But how exactly it could affect your scores depends, in part, on your overall credit profile.
Paying off a vehicle loan early can have an impact on your credit score. The effect is usually small and temporary, but understanding how it works can help you make the best financial decisions In this article, we’ll look at how your credit is affected when you pay off an auto loan ahead of schedule.
How Credit Scores Work
Your credit scores, including your FICO® Score, are calculated based on information in your credit reports from the three major credit bureaus – Experian, Equifax and TransUnion. Several factors influence your scores, including:
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Payment history – Do you pay your bills on time? Late payments can lower your scores
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Credit utilization – This is the percentage of your available credit that you’re using. High utilization can hurt your scores.
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Credit history length – In general, the longer your history, the better.
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Credit mix – Lenders like to see you’ve managed different types of credit, like credit cards and installment loans.
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New credit – Opening a lot of new accounts in a short time can lower your scores.
Your scores go up when you demonstrate responsible credit management, such as making your payments on time and keeping credit card balances low.
How Paying Off an Auto Loan Affects Your Credit
Paying off an installment loan like a car loan or mortgage eliminates one of your open installment accounts. This affects a couple aspects of your credit:
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Credit mix – Having open installment loans and revolving accounts (like credit cards) improves your mix. Closing an installment account could hurt your mix temporarily.
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Length of credit history – Keeping accounts open longer strengthens your history. Closing an account shortens the average age of your accounts.
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Number of open accounts – Having several open accounts in good standing helps your scores, especially if you have a thin credit file. Closing an account subtracts from your total number of open accounts.
On the positive side, paying off an installment loan shows you’re able to successfully manage this type of credit. Paying the loan early also means you’ve paid less interest.
However, on balance, when you pay off an installment loan—especially if you don’t have a lot of other credit—your scores often dip a little at first. Don’t worry too much about small dips after paying off a loan. The effects are usually minor and your scores often rebound in a few months.
When Paying Off an Auto Loan Can Help Your Credit
There are some situations where paying off your car loan early makes sense for your credit:
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You have plenty of other installment loans – With multiple open installment accounts, closing your auto loan won’t hurt your credit mix.
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Your loan has a short time left – Eliminating a loan that will be paid off soon anyway minimizes the impact on your history length.
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You have lots of accounts – With a robust credit profile, one closed installment account isn’t as big of a deal.
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You need to improve your debt-to-income ratio – Paying off debt can allow you to qualify for a mortgage or other loan.
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Your car loan has a high interest rate – The interest savings could outweigh a small drop in your scores.
When It May Be Better to Leave Your Loan Open
Here are some situations where keeping your auto loan open might be the best option:
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You have only a few open accounts – Closing your loan could disproportionately ding your thin credit file.
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Your loan has a low interest rate – If your rate is very low, like 0%, there’s little financial incentive to pay off the loan early.
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You have high interest rate debts – It may make more sense to pay down credit cards and other debts before putting extra cash toward a low-rate auto loan.
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You have a short credit history – Keeping accounts open longer helps build your history, so you may want to maintain your auto loan.
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You’ll be applying for new credit soon – Having open installment accounts can improve loan approval odds, so you may opt to keep your car loan open.
Tips for Minimizing Credit Score Impacts
If you decide paying off your auto loan early aligns with your financial goals, there are steps you can take to minimize effects on your credit:
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Check your credit first – Review your credit reports and FICO® Scores to understand your starting point before paying off the loan.
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Pay it off slowly – Making extra principal payments over time lessens shock to your scores compared to a single payoff.
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Leave your loan open if allowed – Some lenders let you pay in full but keep the account open. This prevents credit mix impact.
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Wait to apply for new credit – Before applying for a mortgage or other loan, give your scores time to stabilize after paying off your car loan.
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Consider loan refinancing – If your credit has improved since you got your car loan, refinancing could lower your interest rate instead of paying it off early.
The Bottom Line
Paying off your auto loan early can lower your total loan costs. But weigh the potential interest savings against the short-term impact on your credit. With a robust credit profile, your scores likely won’t take much of a hit. However, if you have limited accounts or credit history, you may want to take a more gradual approach.
Check your credit reports and FICO® Scores, then evaluate your entire financial picture. This will allow you to decide if paying off your car loan early aligns with your overall credit and money management goals. Responsible use of credit over time is the key to enjoying long-term credit health.
Your lender charges prepayment penalties
Some lenders could charge a prepayment penalty if you pay off the loan early. While you could still save money overall, it may help to review the terms of the loan and find out whether the savings are worth itâor whether youâre better off using the money elsewhere.
How does a car loan impact your credit scores?
Like other installment loans, an auto loan can impact your credit scores in different ways even before you pay it off:
- Payment history: Making your car payments on time can help your credit, but missing a payment or making late payments could hurt your credit scores.
- Debt: Installment balances donât have as much of an impact on credit scores as revolving credit utilization ratios do. But the balance of your loan compared to the total loan amount can still be a factor in scoring.
- Age of accounts: The average age of your accounts can also affect your scores, and a higher average age is usually better. Your car loan will typically be part of the calculation and can help your credit over time. The loan could continue to impact your average age of accounts as long as it stays on your credit report, which might be for up to 10 years after you pay off the loan.
- Credit mix: Having a credit mix of open installment accounts and revolving credit accounts can be good for your credit scores.
Paying off a car loan early can also have different effects on various types of credit scores. For example, your auto loan could have more of an impact on industry-specific FICO® Auto Scores than the more generic FICO Score 8.
Will Paying Off My Car Early Tank My Credit Score?
FAQ
How much will my credit go up after paying off a car?
Why did my credit score drop 100 points after paying off a car?
You paid off your car, and the personal loan, which closes that line of credit. That means your overall credit score goes down, because the amount of lines of credit, as well as credit age dropped.
How can I raise my credit score 100 points in 30 days?
Will paying off a car loan boost credit score?
How Paying Off Your Car Loan Early Can Impact Your Credit. There’s usually a slight dip in your credit score after you pay off a loan. The dip is temporary, though, and your score should rebound in a few months if there are no negative items in your credit report.