If you're one of the over 107 million Americans who has a car loan, you'll want to know if paying it off will help improve your credit score. Since a credit score is used to determine your insurance rates, employment prospects and even the apartment you rent, doing all you can to get in the good and excellent range is key. Paying off your car loan not only lowers your total debt, but it also eliminates additional interest accumulating on the note. Unfortunately, paying off your car loan does not improve your credit score very much. In most cases, paying off your car loan is a neutral act that does not improve or lessen your credit score.
Generally, paying off your car loan won't increase your credit score and instead has a neutral effect. In cases where it reduces your overall account age and diversity of accounts, it can even have a negative impact on your score.
The number one indicator of good credit is a long history of on-time payments. In fact, around 35 percent of your score is your payment history. You want your established accounts to be open for a good period of time with no derogatory information on your report. Paying off your car loan early shortens the amount of payment history entered on your credit report, which does not increase your credit score.
The advice to pay your credit accounts refers to your credit utilization. Credit utilization accounts for 30 percent of your credit score. Credit utilization refers to the amount of debt you have in relation to your credit limits. The conventional advice is to keep your balance around 25 to 30 percent of your credit limit. Utilization weighs heavily in revolving credit but less in installment loans. So, paying down your car loan will not have the positive impact in your total credit utilization as a credit card would.
Closing the Account
Paying off your car loan immediately closes the account. You no longer get monthly updates of positive payment history increasing your credit score. As time goes on, the positive impact of the loan on your credit score lessens. You want active reporting on your credit report to increase your credit score. Open, active accounts are weighed more heavily than closed accounts.
MyFICO estimates that the age of your accounts makes up 15 percent of your credit score. Once your car loan account is paid off, the age of your account history is lessened, which could adversely affect your credit score. You want your credit accounts to be open for a long time to positively impact your credit score.
Types of Credit
For the best credit score, you want a mixture of credit accounts on your report. By utilizing credit cards, auto loans, student loans and even mortgage loans, you show a positive history of using a large mix of credit. This usage shows your potential creditors you know how to responsibly handle all manner of debt.