Chris Scott
Contributing Writer at Tally
February 28, 2022
If you financed a car purchase, you’re likely looking forward to the day when the auto loan is completely paid off. You may have even wondered, "how much does your credit score increase after paying off a car?"
We'll answer that question and more. Specifically, we'll cover what you can expect to happen to your credit score when you pay off a car loan, why this is the case, and the things you can do in preparation. By the end of this article, you should better understand how your credit history will be impacted when you pay off your car loan.
What is a credit score?
A credit score is a three-digit number lenders use to evaluate your creditworthiness. Essentially, it summarizes the information contained in your credit report. When you apply for a new credit account, your potential new lender will look at your credit score to determine whether you should be approved and, if so, the rate you will receive. The best rates are typically reserved for those with excellent credit scores.
How you manage your personal finances and debt goes a long way toward determining your credit score. The types of debt that can impact your credit score include:
Student loans
Mortgages
Auto loans
Personal loans
See AlsoHow much will my credit score go up if I add a new credit card to my wallet?How Much Credit Should I Have, And Does It Impact My Credit Score?How Many Points Will My Credit Score Increase When A Collection Is...How Much Will My Credit Score Go Up When Added To The Electoral Roll? | UK | LoqboxDebt consolidation loans
Lines of credit
Other types of lending
There are two types of credit scores: FICO Scores and VantageScores. Both consider similar factors when determining your score, though they weigh these factors differently. Your FICO credit score is calculated based on the following:
Payment history: 35%
Amounts owed: 30%
Length of credit history: 15%
Credit mix: 10%
New credit: 10%
VantageScore doesn't define the exact percentages they use to determine scores, but they do outline the various factors they consider:
Total credit usage, balance and available credit: Extremely influential
Credit mix and experience: Highly influential
Payment history: Moderately influential
Age of credit history: Less influential
New accounts: Less influential
Now that we've established how credit scores work, let’s look at what you can expect to happen when you pay off your car loan.
How much does your credit score increase after paying off a car?
As a borrower, you've probably worked hard to make on-time car payments and are anticipating the day you can pay off your auto loan. You may even hope this will have a positive impact on your credit score.
Unfortunately, this may not necessarily be the case. Paying off your car loan could harm your credit score. However, the good news is that this impact could be minimal and is likely temporary.
Why does your credit score drop when you pay off your loan? Consider the criteria that go into your FICO Score. One of the major components is "amounts owed." When you pay off your auto loan, you no longer have monthly payments, and you don't owe anything else. As a result, the amount you owe will reflect as "$0," which could lower your score.
Additionally, FICO considers "length of credit history" a component in your credit score. If your car loan is your oldest account, your credit score will decrease when you pay it off. That's because you're reducing your length of credit history. Credit scoring models consider the average age of your accounts, so if you've had your car loan open for a few years, the average age of your accounts is going to decrease when you pay off the loan.
Lastly, paying off your auto loan could impact your "credit mix." Credit scoring models want to see a healthy mix of different types of credit. This includes revolving credit, such as lines of credit and credit card balances, and non-revolving credit, like mortgages and auto loan payments.
Let's say that you have three types of open accounts — two credit card accounts and an auto loan. When you pay off the auto loan, you'll only have credit card accounts. This, in turn, will harm your mix of credit, as you only have one type of credit on your report.
All of this aside, you shouldn’t base your financial decisions solely out of potential harm you may do to your credit score. Meaning if you can pay off your auto loan on time, you should do so. Practicing good financial habits will go much further when building credit. If you manage your other accounts responsibly, the credit hit you take from paying off your car loan should be temporary.
How can you protect against a potential credit score decrease?
Your score may take a temporary hit when you pay off your car loan, but if you've managed the loan responsibly up until that point, you shouldn't have too much to worry about. Any time you make a major change to your credit history, like adding or closing an account, your score may drop slightly.
Make sure to avoid late payments during your loan term by making on-time payments in full. The positive impacts will influence your credit score for years if you do. Once your car loan is paid off and you close the account, you can expect the account to remain a part of your credit history for the next ten years.
Keeping your account in good standing with your creditor can help build your credit score so that you won't have to worry about the temporary hit that comes with paying the loan off. When you pay your auto loan off, be sure to practice other sound financial habits, like avoiding credit card debt, to help maintain your good credit score and quickly recover from any temporary drops.
Should you pay your car loan off early?
If you have the opportunity to do so, you may be wondering whether you should pay off your car loan early. In the eyes of the credit bureaus, there is no benefit to paying off your loan early. Your score will probably still decrease temporarily; for the same reasons, it would decrease if you paid it off at the end of the loan term.
However, there may be other reasons for paying off your car loan early. If you have a high-interest rate, paying your loan off early could be a good idea. On the other hand, if you have a low-interest rate and your payments fit comfortably into your monthly budget, you may want to focus on other goals, like building an emergency fund.
Additionally, if you have a high-interest rate, you may consider refinancing your loan. With an auto loan refinance, you could secure a lower interest rate. This may be particularly helpful if you're looking to build credit by establishing your payment history.
By making your interest rate more affordable, you increase the likelihood of making on-time payments and may also increase the average age of your accounts. This could help your credit score, especially if you have bad credit.
Reach out to your financial institution to figure out if an auto loan refinance is possible. You could also secure a new loan from a different lender and use it to pay down your existing balance as a way to refinance your current loan.
However, one other thing to consider when paying off your auto loan early is a prepayment penalty. Lenders often include a prepayment penalty in your contract to prevent you from paying your balance off immediately.
There are often stipulations that indicate the minimum amount of time your loan must be open before you pay off the balance. Ask your lender about prepayment penalties to help evaluate whether it makes financial sense for you to pay off your loan early.
Manage your car payments to help maximize your credit score
If you have an auto loan, you have probably thought, "how much does your credit score increase after paying off a car?" While this question is important, there are other things you may want to focus on instead.
When you pay off your car, your credit score will likely decrease. Don’t panic – that's to be expected, and it should be temporary, especially if you’re properly managing your other loans or credit cards.
Overall, be sure to focus on sound financial management during the life of your loan to help increase your score as much as possible. Aim to make on-time payments in full throughout your loan term. Doing so will reduce the hit your credit score takes when you pay off your loan.
Financial management can be tricky, which is why it's important to stay up to date with the latest information. One way to do so is by signing up for Tally's† newsletter. The newsletter is delivered straight to your inbox, keeping you informed on everything from credit card management to savings tips.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.
