How Paying Off Auto Loans Affects Your Credit Score
If you’re getting near the end of paying on your car loan, congratulations!
This is a milestone that will mean more money in your pocket to save or enjoy. But you may also be wondering what effect it will have on your credit score.
It’s actually something a lot of people are concerned with, especially if you plan to purchase a home and need your credit score to be as high as possible.
So let me explain the implications to your credit score and hopefully set your mind at ease.
1. Let’s review the impact on your credit.
Since the rating agencies look at things like payment history, making timely payments, debt-to-credit ratio and other factors, the overall impact of having an auto loan is a positive one.
That’s assuming you’ve been diligent in making your payments on time. But let’s presume you have.
The overall effect on your credit score from having a current loan that you are making payments on is a positive one.
This is because 35 percent of our credit score is derived from payment history. This applies to current loans and the history of paying them on time.
Once a loan is paid off, it becomes part of the credit history metric, which accounts for only 15 percent of your score.
“Having taken out a major loan and paid it in full will
remain a positive part of your credit history.”
2. Credit score versus credit history.
Paying off a car loan, while being a positive move, can actually cause the payment history portion of your score to fall, while the credit history may rise.
Since payment history is worth more, there is a slight chance your score might drop. However, there is another factor that may negate the impact.
Since 30 percent of our credit score is based on our available credit-to-debt ratio, paying off a loan may in fact cause this metric to rise.
The fact that you no longer have this outstanding debt balance can mean your ratio drops to a more attractive level.
The net effect of this will probably work in your favor and cause your overall score to rise.
Any time you can pay off a loan and remove debt from your life, it’s a good thing. Having taken out a major loan and paid it in full will remain a positive part of your credit history for years to come.
And if you continue these good habits, your credit score will continue to rise and you’ll see all of the benefits that a good payment history can bring you.
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