If you’re considering paying off your car loan, you might be wondering how it will affect your credit score. Here’s what you need to know.
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The Basics of Credit Scores
What is a credit score?
Information in your credit report is used to calculate your credit score—a three-digit number that represents your creditworthiness. A higher credit score indicates to lenders that you’re a lower-risk borrower, which could lead to getting a loan with a lower interest rate.
Your credit score is important because it’s used in calculating your credit score—a three-digit number that influences the interest rate you’ll pay for a loan or the credit limit you’ll be extended. A high credit score will get you a lower interest rate, while a lower score could mean you pay more for borrowing.
A FICO® Score is the credit score most lenders use to decide whether to lend you money or approve your loan application. The scores range from 300 (lowest risk) to 850 (highest risk).
The average FICO® Score in the U.S. was 703 in 2019, according to Experian data. That’s a good thing because consumers with higher scores are typically offered better terms on their loans—such as lower interest rates—by lenders.
What is a FICO score?
FICO scores are the most widely used credit scores, and lenders typically consider scores in the 720-850 range to be excellent. A FICO score of 720 or higher is generally considered to satisfy most lender requirements for the best rates and terms on a mortgage loan, car loan or credit card. A score of 650-699 is considered good, and a score of 550-649 is considered fair. Scores below 549 are poor.
How Car Loans Affect Your Credit Score
Your credit score is a numerical representation of your creditworthiness, and it’s used by lenders to determine whether to approve you for a loan and what interest rate you’ll get. A higher score indicates you’re a lower-risk borrower, which could lead to a lower interest rate on a loan. So, it’s in your best interest to keep your credit score high.
How paying off a car loan affects your credit score
This is a good question that we hear a lot. How much will my credit score go up when I pay off my car loan?
The answer, unfortunately, is not as simple as a straightforward number. A variety of factors play into your credit score, and paying off a car loan can affect your score in several ways. Here’s a look at some of the factors involved:
Type of debt: Car loans are installment debt, which is different from revolving debt such as credit cards. Installment debt has fixed payments each month, while revolving debt can fluctuate based on your spending habits. Because car loans are installment debt, paying them off can have a positive effect on your credit score.
utilization rate: This is the ratio of your outstanding debt to your total credit limit. For example, if you have a $10,000 car loan with a $15,000 credit limit, your utilization rate would be 67 percent. The lower your utilization rate, the better it is for your credit score. So paying off a car loan can give your score a boost by lowering your utilization rate.
Payment history: One of the biggest factors in your credit score is your payment history—whether you pay your bills on time each month. Paying off a car loan means one less bill to worry about each month, which can help improve your payment history and give your score a lift.
Age of credit: Another key factor in your credit score is the average age of all your accounts—the longer you’ve had them open, the better it is for your score. So while paying off an old car loan won’t have much impact on your score, closing the account could hurt it because it would shorten the average age of all your accounts.
Bottom line: Paying off a car loan can help improve several factors that affect your credit score—utilization rate, payment history and age of credit—but there’s no guarantee how much it will boost your score because there are so many other variables involved.
How missing a car payment affects your credit score
Your payment history is the most important factor in your credit score, accounting for 35% of your total score. A single 30-day late payment can drop your score by 100 points or more. So, if you’re trying to improve your credit score, one of the worst things you can do is miss a car payment.
When you miss a car payment, your creditor will report the late payment to the credit bureaus. This will show up on your credit report as a negative mark and will remain there for seven years. In addition to negatively impacting your credit score, a late car payment can also result in additional fees and charges from your creditor.
If you’re struggling to make your car payments, there are options available to help you avoid falling behind on payments and damaging your credit score. You can contact your creditor to discuss possible repayment plans or contact a credit counseling service for assistance.
The Bottom Line
If you’re thinking about paying off your car loan early, you’re probably wondering how it will affect your credit score. The truth is, it depends on a few factors. In this article, we’ll break down how paying off a car loan can affect your credit score, and what you can do to maximize the impact.
The importance of a good credit score
A good credit score is important because it can help you get approved for loans and get lower interest rates. A high credit score means you’re a low-risk borrower, which is what lenders like to see. Lenders will be more likely to approve your loan and offer you a lower interest rate if they see that you have a history of making on-time payments.
A good credit score can also save you money over the life of your loan. For example, let’s say you’re taking out a $10,000 loan with a 5% interest rate. If you have a good credit score, you may be able to qualify for a lower interest rate, like 4%. That may not seem like much, but over the life of the loan, it can add up to significant savings.
If you’re planning on taking out a loan in the near future, it’s important to start working on your credit score now. The sooner you start, the better your chances will be of getting a low interest rate and saving money.
How to improve your credit score
There are a number of things you can do to improve your credit score, but paying off a car loan is one of the quickest and most effective ways to do it. Here’s how it works:
When you pay off a car loan, the lender will report the account as closed to the credit bureaus. This will have a positive impact on your credit score because it will reduce your overall debt-to-credit ratio. Additionally, having a record of timely loan repayments will further boost your score.
Keep in mind, however, that paying off a car loan early won’t have an immediate impact on your score. It can take up to 30 days for the lender to report the account as closed, and even then, your score may only increase by a few points. But over time, as you continue to make other positive credit decisions, your score will continue to rise.