When you’re prepared to submit an application for an auto loan, review your credit report and shop around for the finest lenders. To examine rates without hurting your credit score, think about utilizing Bankrate’s auto loan finder.
However, if you don’t like the rate estimates you get or have less-than-perfect credit, it can be worthwhile to look into dealer financing—and then refinance later, once your credit has improved.
Does paying off your car loan early actually hurt credit score?
Your credit score may suffer if you pay off your auto loan early. Your credit score will decrease a few points if you end a credit account. Therefore, while it is typical, delaying the repayment of your auto loan may be a good option if you need to keep your credit score high for other major purchases.
Your credit score could, however, rise with time. Paying off a large obligation, such as a vehicle loan, could raise your credit score if your debt-to-income (DTI) ratio is high.
However, investing your money in high-interest debt or savings may be a better choice. This is because getting a car loan might raise your overall credit score. Even though cars are depreciating assets, establishing a history of timely payments will significantly help you keep and raise your credit score.
Even though paying off your auto loan early shouldn’t have a significant negative effect on your credit score, it will ultimately limit your capacity to raise your score over time.
4 major ways paying off your auto loan early affects your credit
Your credit score is influenced by your payment history, credit mix, credit history, and credit utilization ratio. Each may be impacted if you pay off your auto loan early, so carefully examine the benefits and drawbacks before asking your lender for a payoff estimate.
1. Payment history
Your credit report is updated each time you pay off your auto loan on time, building a solid payment history. These payments raise your credit score over time.
When you pay off a car loan, the account is closed, so you can no longer establish a good payment history. Additionally, even though the loan you took out might be on your credit report for up to 10 years, open accounts have a bigger impact on your credit score than closed ones. They show how you manage credit now as opposed to how you did in the past.
2. Length of credit history
Only ten years are allowed for paid-off vehicle loans to stay on your credit report. Even while it may seem like there is still plenty of time, once it is gone, your credit score will drop. Lenders want long credit histories. You will have well over ten years of credit history established if you keep to your repayment plan and complete your car loan in accordance with your original terms.
You stand a better chance of obtaining a good or exceptional credit score the longer your credit history. It is preferable to keep the vehicle loan open if you’re trying to establish or repair your credit in order to establish a good credit history. The moment you close it, a countdown begins.
3. Credit mix
Lenders prefer to see a good balance between revolving and installment accounts. Revolving accounts like credit cards are useful for controlling your credit usage, whereas installment accounts like vehicle loans are beneficial for lengthening your credit history.
Your credit score can suffer if you pay off a car loan early and it’s the only installment account you have. Additionally, your score could suffer even more damage if you have a small number of accounts overall.
4. Credit utilization
Your credit score is determined by the amount of credit you have available to you and how much of it you actually use. Your credit score may increase if you steadily pay off your loan over time to reduce your credit utilization.
After you pay off your auto loan, it won’t affect your ability to get credit again. If you already have large debts, this could significantly change your credit utilization ratio, which would then affect your credit score.
When to pay your car loan off early
There are situations in which paying off your car loan early is a beneficial option, despite the possible harm to your credit score.
- 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.
In the end, paying off your auto loan early has a negative and positive impact on your credit score. When you first pay off your debt, you should anticipate a slight decrease. But before agreeing to an early payoff, you must decide whether it will raise your credit score over time.