Does paying off a car loan hurt your credit?

Paying off a car loan early: What could be wrong with eliminating a bill each month and freeing space in your budget? Generally, getting free of debt is a good thing. But there are a few things to consider before you do it, including how it might affect your credit.

It may seem backward, but paying off a car loan early could cause your credit scores to dip. That’s not always the case. And how it could affect your scores depends, in part, on your overall credit profile. Before you make that final payment, here are a few things worth thinking about.

Similar to other types of installment loans, an auto loan can impact your credit scores in different ways:  

• Payment history: Making your car payments on time can help your credit, but missing a payment could hurt credit scores. 
• Debt usage: Installment balances don’t have as much impact on credit scores as revolving credit utilization ratios do. But the balance of your loan compared to the total loan amount is still a factor in scoring. 
• Age of accounts: The average age of your accounts can also affect your scores, and a higher average age is usually best. Your car loan will be part of the calculation and can help your credit over time. The loan could continue to impact this as long as it stays on your credit report, which could be for up to 10 years after you pay off the loan. 
• Accounts with a balance: Having multiple accounts with outstanding balances might hurt your credit.
• Credit mix: Having a mix of open installment accounts and revolving accounts could be good for your credit scores. 

Paying off a car loan early can also have different effects on different 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.

Strangely, paying off your car loan early may not help your credit scores. Some of it has to do with a few of the factors listed above. Here are a couple of reasons:

• It lowers your debt usage: Some scoring models see a person paying off installment loans as less risky than a person with no installment loan debt. So paying off a car loan could cause your scores to drop.
• It has an impact on your credit mix: If the auto loan was your only installment loan, then paying it off and closing the account could decrease your credit mix.

But there are other things to think about too—besides how it could affect credit scores. Here are some other ways paying off a car loan early could impact your finances:

• Debt-to-income ratio: Paying off your loan will get rid of one of your monthly bills, which could decrease your debt-to-income (DTI) ratio. A lower DTI can help you qualify for new credit accounts and better interest rates. 
• Prepayment penalties: Some loans could make you pay a prepayment penalty if the loan is paid off early. While you could still save money overall, it may help to review the terms of the loan and find out if the savings are worth it—or if you’re better off using the money elsewhere.
• Higher-interest loans: If you have debts with interest rates higher than the interest rate of your auto loan, you might want to focus on paying off the loans with the highest interest rates first.
• Emergency fund: If you don’t already have one, consider whether you want to start saving money to an emergency fund before paying off your car loan.
• Investments: You could look into investment opportunities that may offer a higher interest rate than you’re paying on your auto loan.

It may help to think about the potential pros and cons before deciding whether to pay off a car loan early. 

While your credit scores might take a hit initially if you decide to pay it off early, your scores could recover as you continue making other payments on time. And if you’re not planning on borrowing money or applying for other credit anytime soon, the score drops might not be as important right now.

Credit scores aside, try to figure out how much you’ll save overall by paying off the loan early. Then compare that to the potential benefit of doing things like paying down other debts. That could give you a clue to which option may be best for you.

And the mental relief of having one fewer bill to pay each month can also be a plus for some people, so it may help to figure out what your priorities are and go from there.