If you have the extra money to pay off an outstanding loan, it may be tempting to do so and be done with it. However, if you’re working hard to pay a loan off early to improve your credit score or establish credit, this tactic will not work. When you make payments on time to a company, creditors see that you’re responsible. Having closed accounts paid in full simply demonstrates past responsible behavior.
Credit Scoring Process
It is actually better for your credit scores -- as rated by FICO and VantageScore -- if you keep the loan open and make monthly payments as scheduled. This shows creditors that you’re responsible and can manage your debt. While paying the loan off early will not hurt your credit score, it also won’t improve it. If paying the loan off early is really important to you, make extra payments over a 24-month period, as VantageScore gives more weight to the first 12 to 24 months of a loan's life cycle. Ultimately, an open account to which you’re making on-time payments may have a more positive impact on your credit score than paying the loan off early.
Alternate Place to Put Extra Money
While paying your loan off early can free up extra money in your monthly budget, you can put your extra money in other places to help your financial situation. Set up an emergency fund so you’ll have extra money to pay for unplanned expenses without going into debt. If you have any other accounts with an overdue balance, settle those debts first. It’s best to pay credit cards off before paying off installment loans.
Reasons to Pay Loan off Early
Paying a loan off early can help you to save a great deal of money on interest charges, and it can be a great relief to settle all your debts and not owe money to anyone. Before opting to pay a loan off early, make sure it’s the most financially savvy move for you. If you’re planning to apply for additional financing, such as a car loan, it may be best to leave the account open and save the extra money toward a larger down payment.
Impact of Late Payments
While paying a loan off early won’t have much impact on your credit score, making late payments can cause severe damage. If you’re more than 30 days late making a payment, your credit score could drop by around 30 points. Accounts left unpaid for three months or more that go to collections can cause your score to drop even more.
Laura Woods is a Los Angeles-based writer with more than six years of marketing experience. She has a Bachelor of Arts in communications from the University of Pittsburgh and an MBA from Robert Morris University.