It makes sense why you’d want to pay off your car loan early. You’ll own your car in full, you’ll be free of your obligation to someone else, you won’t have to pay interest anymore, and, most importantly, you’ll have hundreds of extra dollars each month.
Have you stopped to think about what paying off your car loan might do to your credit, though? You might think that it would boost your score—but is that really the case?
If you’re considering paying off your car loan early, then read on. We’ll talk about what will really happen to your credit after you send that last check in. It might not be what you think!
How do car loans affect your credit?
Car loans affect your credit score in four main ways.
1) Payment History
The most important factor in determining your credit score is your payment history. The more on-time payments you make, the better. If you miss one, your score could tank.
Car loans are great for building an on-time payment record as long as you do, in fact, make your payments on time. This factor, alone, will boost your score more than anything else. Luckily, on-time payments will stay on your record for 10 years after you close your account. Even if you do pay off your car loan early, you’ll still be able to take advantage of this on-time payment boost for that 10-year period.
2) Amount Owed
The second-most important factor in determining your credit score is how much you still owe on your debt. Having small—or even no—balances will boost your credit score in the long run.
However, not all types of debt are treated the same. Having a high balance on your credit cards can be much more damaging to your credit than having a high balance on your car loan. Still, paying off your car loan could boost your credit.
3) Age of Credit History
Creditors like to see that you have a long history of managing your debt well. They actually measure this by taking the average age of all your open accounts.
For example, let’s say you’ve had a credit card for 10 years and a car loan for two years. Your average account age would then be six years ((10 + 2)/2). In general, creditors like to see an average account age of more than five years.
This factor is of medium importance in determining your credit score. It’s still important, but not as much as having a good payment history.
4) Credit Mix
All types of credit—auto loans, student loans, credit cards, etc…—are not the same. That’s why creditors like to see that you can manage a diversity of open accounts. Once you pay off your auto loan, you’ll have one less account type. Luckily, this is one of the least important factors in determining your credit score.
|Secured Credit Card||$35 annual fee (plus security deposit)||Apply|
|Secured Credit Card||$29 annual fee||Apply|
How will paying off your car loan affect your credit score?
You can see that there’s a lot of moving parts to your credit score that your auto loan affects. Payment history, how much you owe, average age of credit history and credit mix all play an important role in calculating your credit score.
Because there are so many moving parts, it’s hard to say with certainty that paying off your car loan will or will not boost your credit score. It all depends on your individual situation.
For example, if you pay off your car loan and bump your average account age from four to six, it could boost your score. But, if you pay off your car loan and drop your average account age from six to four, it could lower your score by a few points.
In another example, let’s say you still have a lot to pay off on your loan. If you pay it off, you could see a bump in your credit score simply from owing less on your accounts.
Again, it all depends on your individual situation. However, take heart in knowing that whether you pay it off or not, whichever direction your credit score goes—up or down—it likely won’t be a huge, dramatic spike.
Should you pay off your car loan early?
It’s almost never a good idea to hold onto debt simply for the sake of boosting your credit score by a few points.
About the only time you’d want to hang onto your car loan is if you’re getting ready to apply for a big loan like a mortgage, and your credit score is just above the threshold for good credit (700-710). In that case, wait to pay off your car loan until after you’re approved for a mortgage, just in case your score drops.
For most people, though, it makes sense to pay off your car loan sooner.
Managing your credit can be a complicated business. You can learn it all by yourself for free, but not everyone was born to wade through piles of boring financial data. If you need help, check out our Debt Help page for some great recommendations on credit counseling, credit repair services, and debt settlements.