One of my clients asked me if paying off a car loan would improve her credit score. In answering her question, I thought to myself that I would share my answer with you, just in case you had a similar thought at one time or another. Anytime you can pay off any of your debt, it is a good thing. That’s one less payment you have to make every month and paying off your car means you now own your car.
The greatest benefit of paying off your car loan doesn’t come from the fact that you paid it off. The greatest asset for you is from your payment history and the successful management of paying an installment loan on time. The fact is your payment history affects your credit score more than paying the loan off.
It is usually a good idea to carry one installment loan on your credit history to help your credit score. The reason for this is because 10 percent of your FICO score is arrived from the different types of loans that you are carrying. If you carry different loans such as, credit cards, revolving credit, installment loans, etc., this shows that you can manage different types of loans and you are more responsible and experienced to handle a loan.
When you pay an installment loan off, like your car, the formula that the credit card bureaus use essentially pays no attention to when you pay your car loan off, when it comes to the variety of your credit. It could lower your FICO score unless you were to have another installment loan on your report.
However, income-to-debt ratios are just as important as your FICO score. Once your debt-to-income ratio is over 40 percent, lenders are more hesitant to loan additional money, because you are already extended thin financially. The good news is that as long as you have made your car payments on-time, the positive payment history will stay on your credit history for 10 years.
If you are thinking about applying for a mortgage in the future, you might consider wanting to wait on paying your car loan off as long as your income-to-debt ratio is in line. If you paid your car loan off you may see somewhere between a 50 to 60 point decrease in your credit score. This decrease in your score could lower your credit rating from excellent to good, thus increasing the interest rate on your new mortgage.
Credit history accounts for 15 percent of your total overall credit score. So by paying your car off, you won’t be getting that 35 percent boost to your score for paying your car on time. But, the history of your paying on time stays on your report for a long time. The age of the account will reap you benefits over the next 10 years towards your score.