Getting rid of your car payment can definitely free up some cash every month, but it might hurt your credit score.
That's because open accounts showing a good record of on-time payments have a powerful effect on your score. Closing an account also may reduce your credit mix and average age of accounts.
Here's what to know about how paying off a car loan early may affect your credit score.
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Your car loan's impact on your credit score
It helps to understand how credit scores work — they’re all about how you manage borrowed money. Continuing to make on-time payments helps build your payment history, which has the biggest influence on credit scores. Closing the account means it's no longer actively contributing to your payment history.
An auto loan is an installment account, that is, one with a set term and a level payment every month. Once your loan is repaid, you could lose points if you don’t have other installment accounts because another factor in your credit score is “credit mix.” The average age of your open accounts may also affect your score. The best scores go to people who have a long history of on-time payments on installment loans and credit cards.
So paying off your car loan — or paying it off early — could actually result in your score dropping a bit.
How do I decide whether to pay it off early?
If you have the money to pay off your car loan early, and particularly if your interest rate is high, you might want to do it. Give some thought to where you stand on other financial goals, such as having an emergency fund, before you commit your money. And think about whether your car loan qualifies as good or bad debt.
If you decide not to devote the money to ending your loan but worry about a high interest rate, you may be able to refinance your auto loan and save money. Try not to extend the length of the loan when you refinance unless your finances have changed and the old payment has become unmanageable. Extending the loan will almost certainly increase the amount of interest you pay.
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Is there an upside to keeping a loan?
There can be an upside to keeping your car loan payment: for instance, you got a 0% financing deal. So paying it off early wouldn't save you money, but you'll continue to benefit from having on-time payments by keeping the loan.
