Paying off your car loan early usually could cause a temporary drop in your credit score, but the dip typically lasts only a few months. However, paying your auto loan off early may not be the best use of your money if you have high-interest debt or your car loan has a low interest rate.
When you pay off a loan early, it can be freeing to have less debt and more money in your budget. But before you do anything, you should think about how paying off your loan early might affect your credit and money. Paying off your car loan early can temporarily hurt your credit score, but the effect is usually short-lived. Depending on your financial situation, it may be better to leave your auto loan open than to pay it off early.
Paying off debt early is usually thought to be a smart way to handle money. In contrast, if you pay off your car loan early, it might not have such a clear effect on your credit scores.
This article will talk about how paying off a car loan early might hurt your credit and what you should think about if you want to pay off your loan faster.
How Auto Loans Affect Your Credit
First, it helps to understand how your car loan impacts your credit in the first place Like other installment loans, your auto loan can influence your credit scores in a few key ways
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Payment history – Making timely payments can benefit your credit, while missed or late payments could hurt your scores.
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Outstanding loan balance: The amount you still owe on your car loan is taken into account when figuring out your credit score, but not as much as your credit card balances.
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The length of your credit history—An auto loan can help you build your history, and it may stay on your report for up to 10 years after you pay it off.
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Credit mix – Having both installment loans (like an auto loan) and revolving accounts (like credit cards) can be positive for your credit mix.
How Paying Off Early May Lower Scores
It may seem counterintuitive, but paying off your car loan early could result in a slight temporary drop in your credit scores. Here are some potential reasons why:
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Credit scoring models may see borrowers with open installment loans as less risky – So if your paid-off auto loan was your only open installment account, losing it could negatively impact your credit mix.
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Average age of accounts could decrease – The age of your credit accounts is a factor in credit scoring. If your now-closed auto loan was one of your oldest accounts, paying it off early could bring down your average account age.
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Immediate access to credit decreases – After paying off your loan, you’ll have less available credit overall (unless you take out another loan), which could affect credit scoring calculations.
The degree scores drop may depend on your overall credit profile. And over time, responsible credit habits could help offset any dips.
Weighing the Potential Credit Impact
While paying off your auto loan faster could cause a slight credit score decrease, there are also positives to keep in mind:
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You’ll pay less interest by eliminating your loan sooner. Calculate potential savings to see if it’s worthwhile.
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Your monthly cash flow will improve without a car payment.
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Your debt-to-income ratio will decrease, which can help qualification for future loans.
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You’ll minimize the risk of being underwater on the loan.
So is it still worth paying off your car loan early? Here are some key factors to think through:
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Will you need to access credit soon? If so, consider how early payoff could temporarily affect your credit scores.
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Do you have other high-interest debt? You may want to focus on paying those balances first.
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Is your emergency fund built up? If not, you could prioritize saving over extra car loan payments.
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Does your lender charge early payoff penalties? Calculate if the fees outweigh interest savings.
Strategies for Paying Off Your Auto Loan Faster
If you decide it makes sense to pay down your car loan ahead of schedule, here are tips for doing so:
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Make one large lump-sum payment – Have enough savings to pay it all off at once. Get the payoff amount from your lender.
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Increase your monthly payment – Even small increases help pay off principal faster and reduce interest paid over time.
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Add extra payments – Consider making an extra payment whenever you have extra funds like tax refunds or bonuses.
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Refinance your loan – Shop around to see if you can get a lower rate on the remaining balance through refinancing.
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Trade in your car – Swap your current vehicle for one with little or no loan balance.
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Use windfalls – Put tax refunds, work bonuses or other unexpected cash toward your loan principal.
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Make payments biweekly – This allows you to make 26 half-payments a year rather than 12 full payments.
The bottom line? Weigh the pros and cons, do the math, and assess your own financial situation. With some planning, paying off your car loan early could end up being a savvy money move.
You Need to Improve Your Debt-to-Income Ratio
Lenders may consider your debt-to-income ratio (DTI)âyour total monthly debt payments compared to your total monthly earningsâwhen deciding whether to offer you credit. For example, when you apply for a mortgage, lenders generally require a DTI below 50%, and some have lower limits, such as 43% or even 36%. Paying off your auto loan early could improve your odds of qualifying for a mortgage.
How Paying Off Your Car Loan Early Can Impact Your Credit
Theres 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.
Paying off a car loan early sounds like a good thing, so why would it negatively affect your credit? There are a couple of reasons:
- It may hurt your credit mix. Having a mix of credit typesâincluding installment accounts, such as car loans, and revolving accounts, such as credit cardsâtypically benefits your credit score. Your score may drop if the auto loan was the only open installment loan you had.
- It reduces your number of open accounts. When you have a thin credit file (that is, only a few credit accounts), every open account can benefit your credit score. Closed accounts that were always paid on time can positively impact your credit, but not as much as open ones. In this case, keeping your car loan open could be more helpful than paying it off early.
Will Paying Off My Car Early Tank My Credit Score?
FAQ
Is paying off a car loan early good for your credit?
It wouldn’t hurt your credit, at least long term. You may see a bit of a drop when you initially pay it off, but overall, it would likely strengthen your credit profile and you will have less overall debt.
Why did my credit score drop 100 points after paying off my car?
A drop in your credit score after paying off a car loan, even a significant one like 100 points, is not uncommon. Several things can cause this, such as a change in your credit mix, the ending of an installment loan, or a short-term drop because you no longer have a good payment history for that loan.
How much will my credit score go up if I pay my car off early?
In the short term, paying off your car loan early will impact your credit score — usually dropping it by a few points. Over the long term, it may rise because you’ve reduced the amount of debt you owe.
What are the disadvantages of paying off a car loan early?