Does paying off a personal loan early hurt credit?

Paying off a personal loan early could have a negative impact on your credit scores because it can impact credit-scoring factors, like payment history, length of credit and credit mix. But any dip in your credit scores will likely be temporary and minor.

What you’ll learn:

• Your credit score could drop if you pay off a personal loan early, but this will likely be minor and temporary.

• Paying off a personal loan entirely can affect your credit score because of factors like your payment history, length of credit and credit mix. 

• The benefits to paying off a personal loan include reducing your debt-to-income (DTI) ratio and saving on interest over the course of the loan.

• Before deciding to pay off a personal loan early, it’s a good idea to check whether there’s a prepayment penalty.

While paying down debt can improve your credit in the long run, you may see a temporary dip after paying off a loan in full. That’s because paying off a loan can impact one or more of the factors credit-scoring companies typically consider when assessing your credit scores—payment history, debt, credit age, credit mix and new credit.

Here’s a closer look at the factors that could be impacted when you pay off a personal loan:

Payment history shows how consistently you’ve made on-time payments toward your accounts. It’s a major factor in determining your credit scores when using the most common credit-scoring company’s models—FICO® and VantageScore®. 

Payment history information can stay on credit reports for up to 10 years. But once a personal loan account is closed, any record of positive payment history might have less impact on credit compared to an open account.

The length of your credit history can factor into your overall credit scores. Longer-standing accounts can have a positive impact because this can demonstrate an established borrowing history to lenders. If a personal loan is an older account on your credit report, closing it could potentially lower your credit scores by reducing the average age of your credit history.

The different types of open credit accounts you have can influence your credit scores. A combination of installment loans, like personal or auto loans, and revolving credit, like credit cards, can show lenders that you can responsibly manage various types of accounts. 

If your personal loan is one of the only installment loans on your credit reports, closing it could lower the diversity of your credit mix.

If paying off your personal loan early is part of your debt payoff strategy, here are a few potential advantages to consider:

• Reduces your DTI ratio: Paying off a personal loan early could improve your DTI ratio—or how much debt you have compared to your income. Lenders often use this ratio when determining whether or not to extend credit or a loan to you.

• Saves on interest: By paying off a personal loan ahead of schedule, you reduce the amount of interest you’d pay over the life of the loan. But you might want to read the fine print of your loan terms for any prepayment fee and compare that to the interest you could save.

• Lowers your total debt: Eliminating your personal loan could reduce the amount of overall debt that you have. This could mean one less monthly payment that you have to make.

Paying down debt is generally a smart financial move. But there are certain situations when you might choose to continue making regular payments on a personal loan rather than pay it off early.

If you currently have a low interest rate on your personal loan, it could be worth first paying off other debts you may have. For example, if you have both a personal loan with a low interest rate and a credit card with a high interest rate, you may decide to put any extra money toward paying down the credit card debt.

Using cash to pay off a personal loan can reduce your overall monthly payment obligations. But you might reconsider if you’re using money from an emergency fund to pay down this debt. That’s because it’s a good idea to have cash readily available if an unexpected event were to occur.

Paying off an installment loan entirely can result in a slight temporary dip in your credit scores. If you know your credit scores are going to be reviewed as part of an application for a mortgage or an auto loan, you might choose to postpone paying off a personal loan. 

If you want to know where you stand financially, CreditWise from Capital One lets you monitor your credit health for free—without impacting your credit scores.

Some lenders may charge a prepayment penalty if you pay off your personal loan before the term ends. This fee is meant to protect the lender from losing revenue on interest. Before paying off a personal loan early, you might want to read the agreement or ask the lender about its prepayment terms.

Paying off a personal loan early can have advantages and disadvantages. Even though your credit score may take a slight hit, paying off a loan early can lower your DTI ratio and help you save on interest. 

Worried about your credit fluctuating when you pay off a personal loan early? Even if your score drops a few points, you could use other credit-building methods to repair or maintain a good credit score. Before paying off the loan, you can see how it might affect your credit score with the CreditWise Credit Score Simulator from Capital One.

Whether you choose to pay off your personal loan early or put any extra cash toward something else is up to you. By understanding the pros and cons of an early payment, you can make informed decisions with your money.