Does Paying Off a Car Loan Early Hurt Your Credit?

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

• Payment history – Making timely payments can benefit your credit, while missed or late payments could hurt your scores.

• 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.

• 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.

• 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:

• 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.

• 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.

• 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:

• You’ll pay less interest by eliminating your loan sooner. Calculate potential savings to see if it’s worthwhile.

• Your monthly cash flow will improve without a car payment.

• Your debt-to-income ratio will decrease, which can help qualification for future loans.

• 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:

• Will you need to access credit soon? If so, consider how early payoff could temporarily affect your credit scores.

• Do you have other high-interest debt? You may want to focus on paying those balances first.

• Is your emergency fund built up? If not, you could prioritize saving over extra car loan payments.

• 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:

• Make one large lump-sum payment – Have enough savings to pay it all off at once. Get the payoff amount from your lender.

• Increase your monthly payment – Even small increases help pay off principal faster and reduce interest paid over time.

• Add extra payments – Consider making an extra payment whenever you have extra funds like tax refunds or bonuses.

• Refinance your loan – Shop around to see if you can get a lower rate on the remaining balance through refinancing.

• Trade in your car – Swap your current vehicle for one with little or no loan balance.

• Use windfalls – Put tax refunds, work bonuses or other unexpected cash toward your loan principal.

• 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.