Does Paying Off Your Car Loan Early Hurt Your Credit Score?
If you’re getting close to the end of your car loan term, you may be asking yourself, “Will paying off my car hurt my credit?”
In short, paying off your car loan early may hurt your credit score, but the effects of paying off your car loan early are usually only temporary.
However, some lenders may issue prepayment penalties to make up the money they’ll be losing by not collecting interest on the loan—so, before you decide to pay off your auto loan early, it’s best to check with your lender to see if there are any prepayment fees or penalties.
Credit Union of Southern California (CU SoCal) provides checking, savings, and auto loan products with quick pre-approvals, no application or funding fees, and more!
Call CU SoCal at 866.287.6225 to schedule a free no-obligation auto loan consultation, or apply online today!
Why Does Paying Off A Car Loan Hurt Your Credit
According to the credit bureau Experian, whenever you make a major change to your credit history (like paying off a car loan), your credit score can drop; however, this drop is usually only temporary.
What Are The Dangers Of Paying Off Car Loan Early?
Paying off a car loan early can temporarily affect your credit score, but the major concern is prepayment penalties charged by the lender.
Some banks, credit unions, and financing companies will charge a prepayment penalty for paying off a car loan early. They do this to make up for the money they’ll lose by not collecting the long-term interest on your loan.
Be sure to check with your lender before you make an early pay-off.
How Does Credit Scoring Work?
Credit scoring awards points for factors related to your debt and how you repay that debt, such as on-time payments and length of credit history, which helps lenders predict who is most likely to repay a debt. Not only is credit a consideration lenders use to determine eligibility to borrow, it plays a role in the interest rate you’ll be offered on a loan.
The most widely use credit scores are FICO® Scores
, developed by Fair Isaac Company, Inc. FICO Scores are calculated using many different pieces of credit data in your credit report. This data is grouped into five categories: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%).
When Does it Make Sense to Pay Off Your Car Loan Early?
Paying off your car loan early can save you money in interest payments, and could give you other benefits. Here are the top three times when it makes sense to pay off your car loan early.
- Your Loan Has a High Interest Rate. A high interest rate loan means you’re paying more each month on your initial loan amount. If you have the cash to pay off your car loan, without neglecting other debts, then paying off your car loan is a great idea.
- You Want to Improve Your Debt-to-Income (DTI) Ratio. Lenders look at a person’s Debt-to-Income (DTI) Ratio to determine if the potential borrower will be able to afford to pay a new loan, such as a home mortgage. Paying off your car loan will reduce your DTI ratio, making it easier to get other types of loans.
- You Have a Good Credit Mix. A car loan helps to improve your credit mix, which contributes to a better credit score. If you already have established a good credit mix and pay your loans and debts on time, then you don’t need to hold onto your car loan for this purpose.
For more details, check out “7 Tips for Paying Off Your Car Loan Early
When Is it Better to Keep the Loan?
There are times when keeping your car loan can actually work in your favor. Here are the top three times when it’s better to keep your car loan.
- When You Have a Low Interest Rate. If you were lucky enough to score a 0% APR on your car loan or the interest rate is very low, then, depending on how many years you have left on the loan, you may consider keeping it. If you want to purchase investments or contribute to high yield accounts that earn more interest than the interest you pay on your car loan, then the better investment would be to keep the loan and make your money work for you in other ways.
- If You Lack Emergency Funds. If you don’t have six months of emergency funds in the bank or are low on savings, then it’s better to continue with your loan. Paying off the loan could leave you short of cash that would be needed should you lose your job or have a financial emergency.
- When You're Close to Paying Off Your Loan. If you only have a few more loan payments to go, paying off your car loan early won't save you a significant amount of interest. According to the credit bureau Experian, in this case, it's better to keep the loan, make those remaining payments on time, and benefit from the positive effect this will have on your credit score.
How Long Will My Credit Score Be Affected?
Whenever you make a major change to your credit history—including paying off a loan
—your credit score may drop slightly. If you don't have any negative issues in your credit history, this drop should be temporary; your credit scores will rise again in a few months. If you're trying to establish credit or improve your credit score, keeping a car loan open could be more helpful than paying it off.
How to Build and Improve Your Credit Score
At CU SoCal, we understand you’re more than a credit score, which is why we lend on character and not just on credit scores. If you’ve been turned down for an auto loan because of a low credit score, or need help buying a car with bad credit, we can help. Check out this helpful article, “How to Rebuild and Improve Your Credit Score
.” Also, consider our Credit Builder loan, which is designed to establish credit or improve your score if you already have credit. Learn more.
Why Savvy Consumers Choose CU SoCal
For over 60 years, Credit Union of Southern California has been proudly serving Southern California families. We are the fastest growing credit union in Southern California!
Apply for a CU SoCal Auto Loan Today!
Please give us a call today at 866.287.6225 to schedule a no-obligation consultation with one of our auto loan experts.