Does paying off a car loan early hurt your credit scores?
Paying off a car loan early may cause a small, temporary drop in your credit scores. Usually, this happens because paying off the loan can affect credit-scoring factors like your credit mix and the average age of your credit accounts. For many, any impact is short-lived and scores typically recover over time.
What you’ll learn:
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Car loans and how you manage them can affect credit-scoring factors, including payment history, credit mix and total debt.
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Paying off a car loan early could cause a slight dip in your credit scores.
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Any credit score dip might be temporary as long as you’re practicing responsible credit habits with other accounts.
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Paying off a car loan early could reduce the overall interest you’ll pay.
How can a car loan impact your credit scores?
A car loan can impact your credit scores in various ways throughout the life of the loan. As an installment loan, it affects different credit-scoring factors than revolving accounts, such as credit cards. And responsible repayment may help strengthen your credit over time.
Here’s how it can impact your credit scores even before you pay it off:
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Payment history: Making your car payments on time can help your credit, but missing a payment or making late payments could hurt your credit scores.
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Debt: Installment balances don’t have as much of an impact on credit scores as revolving credit utilization ratios do. But the balance of your loan compared to the total loan amount can still be a factor in scoring.
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Age of accounts: The average age of your accounts can also affect your credit scores, and a higher average age is usually better. Your car loan will typically be factored into the calculation and can help improve your credit over time. The loan may continue to affect your average account age as long as it remains on your credit report, which can be for up to 10 years after you pay it off.
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Credit mix: Having a credit mix of open installment accounts and revolving credit accounts can be good for your credit scores.
Paying off a car loan early can also have different effects on various types of credit scores. For example, your auto loan could have more of an impact on industry-specific FICO® Auto Scores than the more generic FICO Score 8.
Benefits of paying off a car loan early
The benefits of paying off a car loan early depend on factors like your interest rate, remaining loan balance and overall financial goals. They include:
Reduced interest payments
You might consider paying off a car loan early to reduce the overall interest you’ll pay. Calculating the potential savings could help you figure out how much you might benefit—and whether that money could be better used for something else.
More room in your budget
Eliminating a car payment from your monthly budget can free up those funds for other obligations or savings. And the relief of having one less bill to pay each month could also be a plus.
Lowered debt-to-income (DTI) ratio
Paying off your loan could decrease your DTI ratio. And a lower DTI ratio can help you qualify for other loans and better interest rates.
Reduced risk of negative equity
As vehicles tend to depreciate over time, your loan balance could potentially become higher than your car’s value. This is known as having negative equity or being underwater on your loan. Paying off your loan early could reduce the risk of negative equity.
Disadvantages of paying off a car loan early
There may be some potential disadvantages to paying off a car loan early. For example:
Prepayment penalties
Some lenders could charge a prepayment penalty if you pay off the loan early. While you could still save money overall, it may help to review the terms of the loan and find out whether the savings are worth it—or whether you’re better off using the money elsewhere.
Opportunity costs
If your auto loan has a relatively low interest rate, consider the opportunity costs of paying it off early. If you have other loans or debts with higher interest rates than your auto loan, you may want to focus on paying off those first.
Additionally, if your savings or investments could earn a higher return than your loan’s interest rate, keeping the loan may make better financial sense.
Depleted savings
Paying off a car loan early may require a substantial up-front payment, which can reduce your cash reserves. Before paying off the loan, consider whether you’ll still have enough savings to cover unexpected expenses.
Credit score impact
Paying off a car loan can cause your credit scores to drop temporarily. So if you’re planning on doing something soon where your credit scores will be checked, like applying for a mortgage, you might want to consider the effects on your credit scores.
How to pay off your car loan early
To pay off your car loan early, you have a few options:
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Make a lump-sum payment. If you have enough money saved up, you might choose to pay off your auto loan all at once. The final payoff amount will include your balance plus any interest or fees you still owe.
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Pay more than the minimum each month. Increasing your monthly car loan payment can help you pay it off faster. Even if it’s a small increase, every little bit could help.
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Make principal-only payments. To maximize interest savings, ensure any additional payment is applied to your loan principal. Depending on the lender, you may need to select a principal-only payment option online or include payment instructions to ensure the funds are allocated correctly.
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Refinance your loan. In some cases, you may be able to refinance your car loan and receive a lower interest rate or better repayment terms. As a result, you might be able to repay your auto loan sooner.
Paying off a car loan early and your credit FAQ
Keep reading for the answers to some frequently asked questions about how paying off an auto loan early can affect your credit:
Does paying off a car loan early help my credit?
This can vary from person to person. Paying off and closing an installment loan account can result in a temporary drop in credit scores. But over time, the lowered debt can improve your DTI ratio, which lenders may look at when considering a credit application.
Why did my credit score go down when I paid off my car?
There are different reasons your credit score might have dropped when you paid off your car loan. It can depend on credit-scoring factors, including credit age and credit mix.
The impact on your credit scores can also vary depending on the credit-scoring company and model that was used to calculate your score. But either way, the drop in credit scores could be temporary if you continue to use credit responsibly elsewhere.
What happens if I pay extra money each month on my car loan?
Paying extra money toward the loan can be helpful, depending on the terms and how the lender applies payments. If extra payments are applied toward the principal, or the initial amount borrowed, you might be able to pay down your loan more quickly and save on interest. But if your loan has precomputed interest, where you pay more interest initially, you may not save on interest charges by paying more each month.
Key takeaways: Paying off a car loan early
Paying off a car loan early may temporarily lower your credit scores, but it could also end up helping you save money on interest.
If you’re considering paying off a loan, understanding your credit score can help you make an informed decision. CreditWise from Capital One can help you monitor your credit health and keep track of any changes to your credit report. You can also get free copies of your credit reports at AnnualCreditReport.com.
