Does Paying Off a Personal Loan Early Hurt Your Credit Score?
A personal loan is considered an installment loan, meaning it is paid-off in fixed monthly increments (installments) over a fixed period of time. (The exception is a personal line of credit, which has more variable terms than a traditional personal loan, discussed here.)
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According to the credit bureau Experian, adding an installment loan to your “credit mix” can improve your credit score because it shows you can manage different types of debt.
However, when you pay off an installment loan, your credit report shows the account as closed, which could cause your credit score to drop. When calculating your credit score, FICO weighs open accounts more heavily than closed accounts.
Open accounts are considered a measure of how you're managing debt in the present as well as the past. Your successful payments on paid off loans are still part of your credit history, but they won't have the same impact on your score. When you close the account, you will now have fewer open accounts and less account diversity. If you paid your loan off early, your history will reflect a shorter account relationship. This can result in a decrease in your credit score.
At Credit Union of Southern California (CU SoCal), we’ve provided low-interest personal loans to Southern Californians for over sixty years.
Even if your credit history isn’t perfect, don’t worry, because unlike a traditional bank, we don’t think that your credit score tells the whole the story. Come in and talk to us and let’s see what we can do!
Call CU SoCal at 866.287.6225 to schedule a free no-obligation personal loan consultation, or apply online today!
What are Personal Loans?
A personal loan is a type of loan that provides the borrower with money that can be used for any personal expense, such as home renovations, paying off debt or medical bills, college tuition, a wedding, and pretty much any other payment need you can think of.
Personal loans are available from credit unions or banks and typically have a fixed interest rate. Many people choose to make large purchases, such as new appliances or furniture using a personal loan because the interest rate often is lower than the interest rate charge by credit cards.
Find out more by reading, “What are Personal Loans?”
Why Paying Off Your Personal Loan Lowers Your Credit Score
Paying off a personal loan early (or any loan for that matter) will have an affect on your credit score. Credit scores can fluctuate daily, as we add and subtract money to and from the debts and loans we have. Although paying off a personal loan early can lower your credit score, the reduction is usually only temporary.
Credit Cards Vs. Loan Installments
Revolving credit is credit that is always available, such as with a credit card or line of credit. There is typically a credit limit, however, you can access and use any amount that’s under the limit, and pay it back in increments on a monthly basis. Credit card rates can be fixed or variable. And, a credit card account is one that will stay open, regardless of whether there's a balance. Most people do not close a credit card, and keeping the account open can help your credit score.
An installment loan is one that is applied for (at a credit union or bank), has a specific interest rate and pay-off terms, including an end date when the loan balance needs to be paid in full. The borrower makes monthly payments according to the terms of the loan agreement. Making on-time monthly payment builds your credit score and helps contribute to your credit mix. Paying off an installment loan will cause a slight temporary drop in credit score.
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. According to MyFICO.com
, This data is grouped into five categories:
Payment History (35%)
shows how you've paid your accounts over the length of your credit. This evidence of repayment is the primary reason why payment history makes up 35% of your score and is a major factor in its calculation. Personal loans, credit cards, mortgage loans, and cars loans are all considered in your payment history.
Amounts Owed (30%)
Having credit accounts and owing money on them does not necessarily mean you are a high-risk borrower with a low FICO Score. However, if you are using a lot of your available credit, this may indicate that you are overextended—and banks can interpret this to mean that you are at a higher risk of defaulting.
Length of Credit History (15%)
In general, a longer credit history will increase your FICO Scores. Your FICO Scores take into account how long your credit accounts have been established, how long specific credit accounts have been established, how long it has been since you used certain accounts. Don’t worry if you don’t have a long credit history, as it is more of a long-term goal. Keeping zero-balance credit cards open is one way to build your credit history.
Credit Mix (10%)
FICO Scores will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. Creditors assess the risk of lending money through a variety of factors, one of them being your ability to successfully manage different types of credit. FICO not only looks at the mix of credit you have but also at the payment history of these credit types.
New Credit (10%)
Research shows that opening several credit accounts in a short amount of time represents a greater risk—especially for people who don't have a long credit history. If you can avoid it, try not to open too many accounts too rapidly.
When to Pay Off a Personal Loan Early
Paying off personal loan early is a personal financial decision. There are times when it makes good financial sense to pay off your personal loan early.
Save on Interest:
If your loan has a high interest rate, then you’re paying more each month on your initial loan amount. If you have the cash to pay off your personal loan, without neglecting other debts, then paying off your loan will save you the money that you would have paid in interest.
Greater Financial Flexibility:
If you have the cash to pay off a personal loan balance, you will save money on interest, and now have more money freed-up to cover your expenses each month. The money you save on monthly interest can be used to pay down other debts or saved to your emergency fund.
No Prepayment Penalties:
Can you pay off a personal loan early? Absolutely, however some lending institutions may charge a prepayment penalty on loans, meaning that if you pay-off the remaining balance before the designated loan term ends, you will have to pay a fee to the lender. Before you sign for a personal loan, be sure to ask if there is a pre-payment penalty. If your loan doesn’t have a prepayment penalty, then paying it off is a good idea if you have the money to do so. Credit Union of Southern California does not charge a prepayment penalty on personal loans.
CU SoCal Personal Loans
Here are some of the reasons why Members love CU SoCal personal loans:
- Amounts available from $500 to $30,000
- No Repayment Penalty
- No Application Fee
- No Funding Fee
- Terms Up To 120 Months For Lowest Possible Repayments
Credit Builder Loan
For individuals who need to establish or build credit, CU SoCal offers a Credit Builder Loan. The Credit Builder Loan is specifically designed for those who have less than optimal credit history, or no credit history at all, and who have time to work on building their credit. It comes with a 12-month term and no application fee. Learn more about CU SoCal's Credit Builder Loan
Don’t let a less than perfect credit score stop you from getting a personal loan. Read “How to Rebuild and Improve Your Credit Score,”
for valuable tips on improving your credit.
Why Savvy Consumers Choose CU SoCal
For over 60 years, Credit Union of Southern California has been proudly serving the Southern California community. We provide our Members with checking, savings, personal loans, auto loans, and other loan products with quick pre-approvals, no application or funding fees, and other unique advantages.
We are known throughout the area for our excellent Member service and we are proud to be serving the community where we work and live.
Apply for a CU SoCal Personal Loan Today!
Please give us a call today at 866.287.6225 to schedule a no-obligation consultation with one of our loan representatives.
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