Credit scores are used by lenders to determine how creditworthy a potential customer is. Credit scores are determined by five categories: your payment history, the amount of money you owe, how long your credit history is, what types of credit you use and whether you have recently applied for new credit. Besides the effects on your credit score, you should also consider the financial implications of paying off your car loan early.
Payment History and Length of Credit
Your payment history is the largest section of your credit score, accounting for 35 percent of your total. Your car loan is an opportunity to show lenders that you can make payments on time. Length of credit totals 15 percent of your score. If you continue to make on-time payments over the life of the loan, you will build up a longer credit history. However, it may not make sense financially to keep paying interest on a loan that you can pay off.
Balances Owed
The amount of money that you owe accounts for 30 percent of your credit score. If you pay off your car loan early, you will decrease the amount of money you owe, which can improve your credit score. However, make sure that you have enough money put aside to cover emergency expenses because if you pay off your car loan but then have to put significant charges on your credit cards, your score will drop because revolving debt, like credit card debt, is weighed more heavily than loans. Paying down your debt will also make you a more attractive customer for future loans.
Types of Credit Used
The type of credit that you use accounts for 10 percent of your credit score. Because the payments on the auto loan count as an installment payment, having a car loan can improve your score if you do not have other installment loans.
Other Considerations
Paying off your car loan early can save you a large amount of money in interest payments because the less time you take to pay back the money the less time interest will be charged on the money you owe. Unlike home mortgage interest, there is no tax deduction for auto loan interest. However, some auto loans charge a significant penalty for paying off your loans early.
Insurance Costs
If your loan requires that you carry a higher level of insurance on a car even though it may be older, you may be able to save money on your insurance by paying of the loan. If you remove the lien from the loan, you will no longer need to carry the extra insurance.
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