How Much Will Credit Score Increase After Paying Off My Car?

If you’re thinking about paying off your car loan, you might be wondering whether paying off your car will increase your credit and by how much. We will answer this question in much detail below.

How Much Will Credit Score Increase After Paying Off My Car?

Your credit score will not increase after paying off your car loan. Oftentimes, paying off a car loan will results in a decrease in your credit score because when you pay off your car, you’re essentially closing an installment loan, which often lowers your credit score, especially if the installment loan was in good standing and substantially paid off. So, before you pay off your car loan expecting your credit score to increase, think again. That said, the decrease in your credit score is temporary, your credit score will bounce back in a few months so long as you continue to make timely payments on all of your other accounts.

Paying off your car can decrease your credit score because slightly because you’re decreasing your credit mix by closing off an installment loan that is in good standing. Typically, you want to have a diverse mix of credit accounts for the best impact on your credit score. So, if you’re thinking about paying off your car loan early to boost your credit score, think again because it often results in a slight but temporary decrease in your credit score.

After you pay off your car loan, if you’ve never missed any payments, the car loan installment account will appear on your credit report for 10 years from the date your account was closed and it will continue to help your credit score.

So, if you want to keep your credit score as high as possible, you should keep your car loan open for as long as possible, meaning don’t pay it off early. However, if you’re coming to an end of your car loan, you should not extend it to maintain the highest credit score possible. The drop you will experience when paying off your car loan is slight and temporary in nature. Typically, credit scores will recover within just a few months.

When is it Good For You to Pay Off Your Car?

It may be a good idea for you to pay off your car loan if any of the following situations apply to you:

  • High Interest Rate – If you have a lengthy auto loan (60, 70, or 80 months) and you’re paying a very high interest rate, you may want to consider paying off your loan because you might save a ton of money that you would have otherwise paid on interest. That said, before paying off your loan, you should check your loan agreement to ensure that your car loan provider does not impose a prepayment penalty for those paying off their car loans early. Also, check your loan to determine whether your interest is precomputed. Precomputed interest means that the amount of interest was calculated and fixed at the outset of the loan, so if you were to pay off your loan early, you would be paying all of the interest as if you had not paid it off early.

  • Debt to Income Ratio – If you want to improve your DTI (debt to income) ratio, you should consider paying off your loan early. This situation often arises when a person is looking to borrow money to buy a home. Some banks may be unwilling to lend a person money if his or her debt to income ratio is too high. In this situation, paying off your car loan may be worth it because it can significantly lower your DTI, depending on how much you owe on your car. Typically, lenders like to see a debt to income ratio below 31%, so if your DTI is significantly higher, paying off your car may be a way to bring this number down, qualifying you for a decent home loan. The lower your DTI, the more likely it is that you’ll be approved for a home loan with reasonable terms and interest rates.

  • Sufficient Open Accounts – If you already have many open credit card accounts, a car loan, a student loan, and other loan types, you may already have a good mix of credit. If you have a good mix of credit, paying off your car may still result in a small drop in your credit score, but such a drop is temporary and your credit score will recover fairly quickly.

When Should You Hold Off On Paying Off Your Car?

You should hold off on paying off your car loan if any of the following situations apply to you:

  • Low Interest Rate – If you have a low interest rate or even a 0% interest rate, it may not make sense for you to pay off your car loan early because the amount of money that you would save is negligible, especially if you’re financing your car at 0% because you will not save on interest. You may benefit from keeping your cash on hand and continuing to make timely payments on your auto loan to establish more good credit history.

  • No savings – You should hold off on paying your car loan if you do not have emergency funds saved up. Keeping cash on hand and continuing to make timely payments is recommended by some experts. This is so because if you lose your job or incur an unexpected expense, you will have some cash on hand to get you through the job loss or unexpected expense.

  • Loan almost paid off – If you’re car loan is almost paid off, there really isn’t a significant reason to pay off the loan early because by the end of your loan, you would have already paid most of the interest due on your auto loan. It’s easier and better to continue making payments until you’ve paid off your car loan. Moreover, your credit score will benefit from the flawless payment history on your car installment loan, boosting your credit score.

What Happens To Your Credit Score If you Pay Off Your Car Loan Early?

Paying a car loan off early is the same as regularly paying off your car when it comes to your credit score. Many people often believe that paying off a car loan early will boost their credit score, but the opposite is actually true, especially if the car loan was in good standing and all payments were made on time. This is so because paying off a car loan early means that you’re closing an installment account, which reduces your credit mix. Oftentimes, when a car loan is paid off early, you will actually notice a slight decrease in your credit score, and this is totally normal.

The slight decrease results because you’ve closed an installment loan that is no longer contributing to your credit score. That said, do not worry if your credit score drops a few points as it will recover so long as you continue to make all of your other payments on time. So, if you were thinking to pay off your car loan early for some bonus credit score points, do not do it because there is no credit boost associated with it.

Frequently Asked Questions (FAQs)

1. Will paying off a car improve my credit?

Paying off your car early will not improve your credit score. In fact, when you pay off your car loan early, your score will slightly drop. That said, when your score drops because you’ve effectively closed an installment account by paying off your car loan, rest assured that your credit score will recover within a few months. Just make sure to keep making the payments on your other accounts on time.

2. How long after paying off a car loan does credit improve?

Experts have stated that your credit score will begin to improve within just a few months after paying off your car loan. Just continue to make all of your other credit card and loan payments on time and your credit score will recover fairly quickly.

3. Why did my credit score drop after paying off my car?

Your credit score dropped when you paid off your car because when paying off your car, you are closing an installment account. This could hurt your credit score for a few reasons. First, it will hurt your credit score because closing an installment account reduces your credit mix, which lowers your credit score when you have less of a variety of open accounts. Second, having an account that is in good standing and substantially paid off boosts your credit score, so closing an account that’s boosting your credit score can lower it slightly.

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

It may be worth it to pay off your car loan early, especially if you are paying a high interest rate for the loan. That said, check your loan agreement to insure that there is no prepayment penalty that would negate the benefits associated with paying off your car loan early. Also, check if your bank requires you to pay the interest due on the account when paying off your car loan early. If both of these two things do not apply, you may benefit from paying off your car loan early.