Does paying off a car loan early hurt your credit?

Paying off debt early is generally a good thing. That includes car loans. But it’s worth understanding how paying off debt earlier than planned might affect your credit.

It may seem backward, but paying off a car loan early could hurt your credit. But how exactly it could affect your scores depends, in part, on your overall credit profile. 

What you’ll learn:

• Car loans and how you manage them can affect credit-scoring factors, including payment history, credit mix and total debt.

• Paying off a car loan early could cause a slight dip in your credit scores. 

• Any credit dip might be temporary as long as you’re practicing responsible credit habits with other accounts.

• Paying off a car loan early could reduce the overall interest you’ll pay.

Like other installment loans, an auto loan can impact your credit scores in different ways even before you pay it off:  

• Payment history: Making your car payments on time can help your credit, but missing a payment or making late payments could hurt your credit scores.

• Debt: Installment balances don’t have as much of an impact on credit scores as revolving credit utilization ratios do. But the balance of your loan compared to the total loan amount can still be a factor in scoring.

• Age of accounts: The average age of your accounts can also affect your scores, and a higher average age is usually better. Your car loan will typically be part of the calculation and can help your credit over time. The loan could continue to impact your average age of accounts as long as it stays on your credit report, which might be for up to 10 years after you pay off the loan.

• Credit mix: Having a credit mix of open installment accounts and revolving credit accounts can be good for your credit scores.

Paying off a car loan early can also have different effects on various types of credit scores. For example, your auto loan could have more of an impact on industry-specific FICO® Auto Scores than the more generic FICO Score 8.

As backward as it may seem, paying off your car loan early may not always help your credit scores. One big reason is your credit mix. 

Some credit-scoring models see a person with installment loans as less risky than a person with no installment loan debt. So if the auto loan was your only installment loan, then paying it off and closing the account could decrease your credit mix.

This might hurt your credit initially, but your scores could recover as you continue making other payments on time. And if you’re not planning on borrowing money or applying for other credit anytime soon, the score drop might not make as much of a difference.

Aside from eliminating debt, there are other potential positives to paying off a car loan early—if it works for your budget.

You might consider paying off a card loan early to reduce the overall interest you’ll pay. Calculating the potential savings could help you figure out how much you might benefit—and whether that money could be put to better use on something else.

Eliminating a car payment from your monthly budget can free up those funds to go toward other obligations or savings. And the relief of having one less bill to pay each month could also be a plus.

Paying off your loan could decrease your DTI ratio. And a lower DTI ratio can help you qualify for other loans and better interest rates.

As vehicles tend to depreciate over time, your loan balance could potentially become higher than your car’s value. This is known as having negative equity or being underwater on your loan. Paying your loan off earlier could reduce the risk of negative equity.

There may be some potential disadvantages to paying off a car loan early. For example, here are some situations when you may choose to put funds toward other things instead of paying your loan off early:

Some lenders could charge a prepayment penalty if you pay off the loan early. While you could still save money overall, it may help to review the terms of the loan and find out whether the savings are worth it—or whether you’re better off using the money elsewhere.

If you have other loans or debts with higher interest rates than the rate of your auto loan, you might want to focus on paying those off first.

If you don’t already have one, you could consider whether you want to start putting money toward an emergency fund before paying off your car loan.

Paying off a car loan can cause your credit scores to drop temporarily. So if you’re planning on doing something soon where your credit scores will be checked, like applying for a mortgage, you might want to consider the effects on your credit scores.

If you decide to pay off your car loan early, there are some different ways you can go about it—depending on your goals and financial situation:

• Make one lump-sum payment. If you have enough money saved up, you might choose to pay off your auto loan all at once. The final payoff amount will include your balance along with any interest or fees you still owe. 

• Pay more than the minimum each month. Increasing your monthly car loan payment can help you pay it off faster. Even if it’s a small increase, every little bit could help. 

• Make additional payments. Similar to the idea of paying more each month, paying more often might be another option.

• Refinance your loan. In some cases, you may be able to refinance your car loan and receive a lower interest rate or better repayment terms. As a result, you might be able to repay your auto loan sooner.

Keep reading to find out more about how paying down an auto loan early can affect your credit.

Paying off a car loan early may temporarily lower your credit scores, but it could also end up helping you save money on interest. 

If you’re considering paying off a loan, understanding your credit score can help you make an informed decision. CreditWise from Capital One can help you monitor your credit health and keep track of any changes to your credit report. You can also get free copies of your credit report at AnnualCreditReport.com