How Much Does Your Credit Score Increase After Paying Off A Car?

If you’re like most Americans, you probably financed your car, and if you’re lucky enough to have paid off your car loan, you might be wondering whether paying off your car increases your credit score and how much of an increase you should expect to see. We will answer these questions in much detail below.

How Much Does Your Credit Score Increase After Paying Off a Car?

Unfortunately, when you first pay off your car, your credit score will slightly go down and will not increase. From my own experience paying off several auto loans, whenever I paid off a loan I noticed a temporary drop of 5 to 10 points in my credit score. This happens because the credit scoring models prefer to see that you have a car loan that’s substantially paid off more than a completely paid off loan. This is so because when you pay off your car, you’re essentially closing down a car loan installment account. Closing an installment account will reduce the mix of credit that you have, causing a small but temporary drop in your credit score.

Your credit mix matters because the credit reporting bureaus reward consumers who have a more diverse credit mix with a higher credit score. Your credit mix accounts for 10% of your credit score. So, the more diverse and the more types of accounts that you have, such as car loans, credit cards, home loans, and student loans, the better your credit score will be. As such, paying off your car essentially closes an auto loan account, which can cause a small yet temporary drop in your credit score.

The second reason paying off your car does not increase your credit score is because when you have a car loan that’s almost completely paid off because you’ve paid off 98% of the amount that you’ve borrowed, this factor helps your credit score because the credit reporting bureaus take into consideration the amount of money that you owe. When you pay off your car loan, you lose this positive factor because your car loan account will appear as paid off.

That said, you should keep in mind that even if your credit score drops due to paying off a car loan, your credit score will quickly recover so long as you made all of your payments on time and continue to make payments on your other credit accounts on time.

The impact that paying off a car will have on your own credit may be different depending on what’s in your credit report. For example, if you have few accounts, paying of an auto loan can result in a bigger drop in your credit score than someone who has several open accounts that are all paid on time. So, your experience will vary depending on what’s on your credit report.

Having said that, even though paying off a car can cause a small dip in your credit score, it’s an excellent thing to have a paid-off car. Having a paid-off account with no missed payments will remain on your credit report for 10 years and will continue to positively impact your credit score so long as it’s on your credit report.

Should You Pay Off Your Car Loan Early?

If you have the money to pay off your car loan early, you should consider the pros and cons of paying it off early.

Saving Money On Interest

The biggest advantage of paying off your car early is that you will save money because you will not have to pay interest on the loan that you’ve taken out once you pay off the principal balance that you owe. That said, you will only save money on your loan if you have a simple interest rate car loan as opposed to a precomputed interest loan.

With a simple interest loan, the interest you must pay is computed each money on the amount of money that you owe. However, with a precomputed interest loan, the interest is computed when you first take out the loan and is baked into the amount of money that you owe. With such a loan, you will not save any money by paying off the loan early because you’ll just pay the interest that you would have paid upfront since it’s included in the account balance.

Pay Off Other Debt

By paying off your car early, you can use the money you’ve saved to pay down other debts that you may have. For example, if you have a student loan or credit card with high-interest rates, you can use the money that you’re saving from paying off your car early to pay down those debts.

Penalties For Paying Off Your Loan Early

Before paying off your car early, you should check to see if your auto loan came with a prepayment penalty. A prepayment penalty is a charge that you are liable for if you choose to pay off your car loan early. Prepayment penalties are often very expensive and are designed to discourage consumers from paying off their loans early so that the lender can make as much money as possible from the interest you pay on your loan.

So, if you’re considering paying off your car early, you should consult your car loan contract to see whether you’ll be liable for a prepayment penalty. If you will still save money after paying this penalty, it may be worth it to pay off your car, however, if the penalty is more than the amount of money that you’ll save, it may be better for you to continue making payments on your until you’ve paid it off.

Better Credit

It may come to you as no surprise that making payments on your car will improve your credit score. In fact, your payment history has the largest impact on your credit score, accounting for 35% of your score. So, keeping your car loan open and making payments on it for longer will definitely build stronger credit for you.

Also, if you’re planning on making a large purchase, such as buying a home, you should avoid paying off your car early. This is so because, typically, when you pay off a car loan, you will notice a slight and temporary drop in your credit score. So, to avoid this small drop in your score, you should push back paying off your car until you’ve completed your purchase.

Bottom Line

Before paying off your car, you should make sure that you have funds set aside for emergencies and that you can continue to make payments on all of your other accounts time. If paying off your car early will put you in a difficult financial situation, you should hold off on paying off your car and just continue making your monthly payment on time.

How to Pay Off Your Car Loan Early?

You can pay off your car loan early by contacting your lender and asking them about how to proceed. Most often, if you want to pay off your car, you would just make a lump sum payment that’s equivalent to the balance on the loan, as well as any interest that you’ve accrued through the day that you’re making the full payment.

What Happens to Your Credit Score When You Pay Off Your Car Early?

Whether you’re paying off your car early or you’re making a regular final payment, your credit score could drop a few points after making your final car payment. This happens because when you pay off your car, you’re essentially closing down an auto loan account. Whenever a big change such as this one occurs, your credit score could drop by a few points. That said, even if you notice a small drop, you should not worry as this drop is usually only temporary. If you made all of your car payments on time and continue to make on-time payments on your other accounts, your credit score will quickly recover and may even become higher than it was prior to paying off your car.

Credit Score Planet Frequently Asked Questions

1. Why did my credit score drop when I paid off my car?

Your credit score may have dropped after paying off your car because big changes, such as closing down an account can result in a small but temporary drop in your credit score. Also, when you pay off your car, you’re closing down an installment account, which can cause a small drop in your credit score.

2. Is it worth paying off a car loan early?

In some circumstances it may be worth it to pay off your car loan early because you may be able to save money on interest. That said, you check your loan agreement before paying off your car loan early because you may have a prepayment penalty on your car loan.

3. Does paying off a car loan hurt your credit?

Paying off a car loan will only result in a small and temporary drop in your credit score. If you made all of your car payments on time, your score will recover quickly and may even exceed the score you had prior to paying off your car loan.

4. How can I raise my credit score?

You can raise your credit score by making all of your credit payments on time, reducing your account balances, keeping old accounts open, and not applying for too much credit within a short period of time.

5. How many points can paying off your car raise your credit score?

Making timely payments on your car can significantly raise your credit score. That said, paying off your car can cause a small temporary drop in your credit score. That said, this may last for a few months, however, if you continue to make payments on your other accounts, your credit score will go up.