Normally, paying off debt is a good thing for a credit score, but expediting your car loan could end up hurting your score. Paying off that car loan, however, could have some tertiary benefits that outweigh the potential negative item of no longer carrying an auto loan. Reread your loan agreement, because accelerated payment may not be an option.
Identification
Ten percent of a credit score comes from the mix of loans a consumer owns. Theoretically, those that handle several types of credit are more experienced and responsible with a loan. Once you pay off an installment, however, the credit scoring formula used by the major credit rating companies essentially "ignores" a paid installment loan when it comes to credit variety. Thus, it may lower your score unless you have another installment loan.
Considerations
Credit scores are just part of the loan approval process. Income-to-debt ratio is just as if not more important than a credit score. Once a consumer's debt-to-income ratio exceeds 40 percent, creditors become extremely hesitant to lend more money, because the borrower's finances are already stretched thin. Also, if you have always paid on-time, that positive information stays on your credit report for 10 years.
Warning
Some auto loan providers include a clause in their agreement that the borrower will pay a fee for paying off the loan early. This fee may be as high as the interest that would have accrued under the normal pay schedule. Thus, paying off the early would not save money nor help your credit score.
Tip
If you plan to apply for a large loan in the near future, such as a mortgage, you might want to hold off on paying that car loan as long as you have a healthy income-to-debt ratio. You could see a 50 to 60 point decrease after paying the car loan, which could drop your score from excellent to good and increase your interest rate on the new loan. Just 0.5 percent on a loan could add up to thousands on a lengthy, expensive loan.
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