Paying off debt is an indication that you’ve managed your finances effectively. As far as your credit score is concerned, however, you’re not doing yourself any favors if you pay off an auto loan early. At best, this reduces the amount of time a positive use of credit remains on your credit report. At worst, it could have a negative short-term effect on your score, though not a major one.
Installment Loan Basics
Installment loans, such as an auto loan, require a set payment for a fixed amount of time. Once the payment schedule has been completed, the loan is paid off and the auto is yours free and clear. You don’t get any benefit from paying off such loans early, or for making more than the scheduled payment each month. While that may fit your budget and your financial needs, as far as the credit reporting agencies are concerned, what matters is simply keeping current on that scheduled payment.
Credit Score Impact
Making regular, on-time payments on installment loans helps your credit score several ways. It diversifies the type of credit you’re managing, which accounts for approximately 15 percent of your credit score. That figure takes into account the number and types of your accounts and will be contrasted with your revolving credit accounts such as credit cards. Another 35 percent of your score is based on your payment history, so continuing to make payments on your installment loan helps boost that portion of your credit score.
Closed Accounts and Credit Scores
Once you pay off your auto loan, it no longer appears as a current account. As a closed account, it no longer factors into your utilization rate, which measures the amount of credit you use compared with your available balance. If you don’t have other revolving accounts, like a mortgage or student loans, this will have a negative effect on that component of your credit score. The specific impact on your score depends on your individual credit history.
Impact Diminishes Over Time
As accounts age, their impact on your credit score diminish, until a successfully paid off auto loan falls off entirely after 10 years. The sooner the account is paid off, the sooner it vanishes from your credit profile. If you’ve made consistent on-time payments, it helps to have the account listed on your report as long as possible. However, if you were behind on your payments and caught up by paying it off, closing the account lessens the impact of those delinquencies, which benefits your score.
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