As much as buying a car may have been a milestone for you, paying off the entire amount may also be something you look forward to. You may be eager to wipe out any debts in the hopes of raising your credit score. Now that you've reached the point where you could actually pay off those obligations earlier than anticipated, you might find it anticlimactic that not only does paying off your car in full not improve your credit score that much, but you may be better off keeping the loan alive.
Revolving Vs. Installment Debt
When you pay off a car loan, you're dealing with what is called an installment debt, which, unlike the revolving debt of credit cards, involves a fixed number of payments over a finite duration. Unlike with credit cards, once you pay off the car loan, the account is no longer active. This may not improve your credit at all, because a certain percentage of the credit rating formula likes to see a mix of different kinds of debt. When you wipe away one type, you're less diversified.
A car loan is designed to be spread out over time -- one of the incentives for paying off a loan is to no longer have to shell out interest-laden payments to your lender. However, some car loans, particularly those offered to those with bad credit, feature a prepayment penalty, which, if you're not able to pay it, could damage your credit.
Early Bird Doesn't Get Worm
If you've entertained the thought of paying off the car loan early as a way of upping your credit score, don't do it, says MSN Money. Given the nature of car loans as installment loans, you might actually be better served by demonstrating a history of timely payments over time, rather than eliminating an account that then becomes closed. If you have the means to pay it off early and want to do so for your own reasons, by all means, get it out of your hair. Just know your credit won't skyrocket because of it.
Payoff for Paying Off
The takeaway is that car financing debts are not like credit card debts. The latter, when paid off promptly, boost your credit score. Paying off car loans, on the other hand, doesn't help your credit significantly. The true payoff for paying off a car loan is the satisfaction that you have fulfilled a long-term obligation and may now use your funds to meet other objectives. Your reward will not necessarily be a higher credit score, but at least one debt burden will be lighter.
Timothea Xi has been writing business and finance articles since 2013. She has worked as an alternative investment adviser in Miami, specializing in managed futures. Xi has also worked as a stockbroker in New York City.