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How Much Does Your Credit Score Increase After Paying Off a Car?

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Auto loans, mortgages, student loans, and most personal loans are types of installment loans that initially appear as a new credit account and represent an opportunity to improve your credit score.

As you make monthly payments over the loan term, you should see your credit scores improve. 

How Much Does Your Credit Score Increase After Paying Off a Car?  

While paying off a balance to your auto lender is an accomplishment, it may actually result in a temporary credit score drop. This may occur because it could reduce the number and age of your active credit accounts, may limit your credit mix, and other factors.

An auto loan is categorized as an installment loan. Unlike revolving accounts such as credit cards, installment accounts have a fixed term, which means that the account closes and is transitioned to an “inactive account” after making the final payment.

While any abrupt decline in your credit score associated with closing your auto loan account (if any) will likely rebound in a couple months, the positive results of having successfully paid off the account will remain for up to 10 years.

Paying off your car loan also will improve your debt-to-income ratio (DTI), which is expressed as a percentage. Here, a future prospective lender will calculate the percentage of your overall income that is allocated to debt.

After paying off a car loan, you should have more disposable or discretionary income each month because you no longer have a fixed commitment of money designated to a car payment. According to Equifax, lenders prefer a DTI of under 30%.

It is important for consumers to recognize that their overall credit profile and score are determined by a more complex and diverse number of factors.  

How Paying Off a Car Loan Affects Your Credit Score

Some borrowers will notice a slight drop in their credit score upon paying off a car loan. The reduced credit score is usually temporary for those with average or better credit history and occurs as a result of an active account becoming inactive.

The models used for calculating scores generally favor active accounts and may result in a marginal decrease. The good news is that your prior auto loan will remain as a “paid in full” installment loan on your credit history for up to 10 years.

Consumers that are most susceptible to a dip in their credit score after paying off their car loan are those with a limited credit history. For example, those with a sparse credit history, such as only having one other credit account, have less positive activity to offset the change.

Paying off the loan early may also improve your debt-to-income (DTI) ratio, which many lenders assess when considering credit applicants. The DTI is the percentage of each month’s income that is allocated to paying a debt.

The majority of lenders require DTI’s to be less than 43%, with 30% or below preferred. 

Also, having successfully paid off a car loan could be a significant benefit if you apply for a future auto loan, as you have demonstrated your creditworthiness in the past.

How Your Credit Score is Calculated 

Decades ago, the Fair Isaac Corporation (FICO) introduced the FICO Score concept, which has since become the leading standard for assessing a consumer’s creditworthiness. FICO Scores are expressed as three-digits that range from 300 to 850. 

The FICO Score proved to be a valuable resource for banks, credit unions, and other lenders who sought a quick and convenient means of determining whether to approve an applicant for a loan, the maximum loan amount, and to determine the interest rate.

FICO Scores represent a summary of a consumer’s credit history that reflects a range of the last 7 to 10 years.

First, let’s understand the estimated credit score ranges.

Credit Score Ranges

ScoreCategory
300 to 579Poor Credit Score
580 to 669Fair Credit Score
670 to 739Good Credit Score
740 to 799Very Good Credit Score
800 to 850 Excellent Credit Score

Source: Equifax Credit Scores

Next, we will review the five largest factors that influence your credit score and the approximate percentages of importance (influence) that each can have.

Payment History (35%)

Your payment history is the single largest factor.  Lenders review your credit history, i.e., auto loan payments and credit card bills, to see if you have consistently made timely payments.

Making late payments has adverse effects because lenders recognize that a consumer’s history of managing debt is likely an indication of future financial behavior.

Amounts Owed (30%)

Another consideration is the total amount of outstanding debt. 

Your credit utilization ratio or rate is a critical factor because it looks at the consumer’s specific credit profile to determine if it suggests a borrower is “overextended”.

Your credit utilization is calculated by looking at the amount of current debt across all revolving credit accounts compared to the total credit limit available. When someone is using a high percentage of their available credit, it suggests they might be having financial difficulties.

For example, assume you have a $500 balance on Card A with a $1,000 credit limit and a $200 balance on Card B with a $1,000 limit.

$500 + $200 = $700 in total credit card debt
$1,000 + $1,000 = $2,000 total credit limit
$700 / $2,000 = .35 or 35% credit utilization rate

The generally accepted standard for what constitutes a “good” utilization rate is 30% or below, with rates below 10% being excellent.

Length of Credit History (15%)

Having a long, well-established credit history will benefit your score — assuming that it is largely positive. The age of your oldest credit account, your most recently opened account, and the combined average age of all accounts are all potential factors.

Those with an older credit card account that they no longer use may want to consider whether formally closing it will have a significant negative impact on their overall length of credit history.

Credit Mix (10%)

Credit mix accounts for about 10% of your overall score and having two or more different categories or types of accounts improves your overall credit report. Examples include mortgages, auto loans, credit cards, etc.

Demonstrating a track record of responsibly managing different types of debt might be the extra boost that your credit score needs to transition your score from the “fair” to the “good” range.

New Credit (10%)

When you apply for credit, the prospective lender accesses your credit bureau report.

The process of checking your report is referred to as an inquiry or “hard credit pull.” Each inquiry is documented on your credit report and remains for two years; however, FICO Scores only factor in inquiries from the prior 12 months.

Research suggests that consumers who suddenly apply for or open multiple credit accounts may be experiencing some abrupt financial problems and be at greater risk.

In today’s competitive financial environment, individuals will commonly apply for credit from multiple lenders to shop for lower interest rates or annual percentage rates (APR); therefore, in most cases, the inquiries are combined or treated as one.

FAQs

How Long After Paying Off a Car Loan Does Credit Improve?

According to a director of consumer education with Experian, paying off a longer-term loan may create some volatility in your credit score. However, any drop in your credit score is generally temporary and it usually “bounces back” in a couple of months.

Keep in mind that a dip in your credit score that stems from paying off a loan often takes more than one month to occur. The reason is that your loan billing cycle and the lender’s credit bureau reporting dates are unlikely to coincide.

Paying off your car loan is generally a positive event regardless of whether your credit score dips. You should feel a sense of accomplishment and now have some extra monthly income to allocate to paying down other debts, building your savings, and other positive activities.

Is Paying Off a Car Loan Early Worth It?

Paying off your vehicle loan early may be smart depending on your individual circumstances. For example, if your loan has high-interest rates, paying it off early may significantly reduce the overall amount of interest you would pay if you paid over the full remaining loan term.

Those with a long credit history are less likely to experience a significant drop in their credit score from paying off a car loan early because they have substantial other credit activity to offset it.

In some cases, consumers might be wise to pay the car loan off according to the existing schedule. For example, those with a 0%, or otherwise very low-interest rate, may be better served spending any extra money to pay down accounts (debts) with higher interest rates.

People who have little to no emergency savings might also think twice before paying off the loan early. 

Before moving forward with paying off your car loan early it is important to review the terms of the loan agreement for any potential prepayment penalties that might apply to the loan.

Does Paying Off Your Car Loan Early Hurt Your Credit?

Paying off your car loan early often will result in a slight and/or short-term decline in your credit score. This is often the result of lowering your credit mix, such as if your car represents the only installment-type of loan on your credit history.

Lenders prefer that consumers show responsible use of credit across multiple categories of debt (a mix), which might include mortgage loans, revolving accounts like credit cards, etc. Keep in mind that your credit mix only represents up to 10% of what determines your credit score.

Paying off a car loan early also reduces the number of active accounts on your credit report. Having open accounts shows a very current history of managing your credit, rather than just a past history.

Consumers must remember that credit scores are based on a broad scope of factors beyond simply one car loan. Focus on always making timely payments, minimizing excessive levels of debt, and having savings on hand for emergencies instead of relying on credit.

CreditStrong helps improve your credit and can positively impact the factors that determine 90% of your FICO score.

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