Does Paying Off a Loan Early Hurt Your Credit Score?

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In the world of personal finance, there are few subjects as engrossing as the credit score. Financial services providers want to know how consumers will handle credit, and are obsessed with checking credit. Consumers themselves are interested in keeping their scores in tip-top shape so they can save money by getting access to the best interest rates and other good deals.

With credit scores considered so important, many consumers are interested in making sure that they do what is best for their scores, it’s no surprise that the most conscientious make special efforts to consider how each financial move they make will impact the credit score. This even extends to paying off loans early.

How Your Loans Impact Your Credit Score

First of all, it’s important to understand how your loans impact your credit score. Because a credit score is the result of information about how you handle credit, your loans make a big difference.

The factors that make up your credit score include your payment history, your debt utilization, the length of your credit history, your new credit, and the types of credit you have. When you make on time payments on your loans, you create a positive credit history. Additionally, your credit score takes into account the types of credit you have, including revolving credit (like credit cards) and installment credit (like car loans).

When you pay your credit cards down regularly, you benefit from making on time payments, as well as from the fact that you keep down the amount of credit you are using relative to how much you have available. Installment loans are a little different, though. Since an installment loan is paid off over a set period of time, you don’t get the credit boost from debt utilization. The benefit of an installment loan is that you can show you can manage your credit responsibly over a long period of time, seeing a good credit history as well as loan diversity and regular payment.

Paying Off Your Credit Card

When you pay off your credit card, you can see a boost to your score, especially if you have carried credit card debt for quite some time. Getting rid of that debt can boost your score, thanks to the importance of credit utilization. However, even if you pay off your credit card, you might not want to cancel it.

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Canceling your credit card can shorten your total credit history, as well as affect your credit utilization. The negative impact to your credit score is likely to be short-lived, however. But you might be better off keeping the credit card account open — provided you can avoid the temptation to get back into debt.

Paying Off Your Installment Loan Early

In most cases, paying off an installment loan, such as your student loan, car loan or mortgage, early won’t hurt your credit score. However, you could be missing out on some chances to improve your score when you pay off an installment loan early. By keeping your installment account open, you have the chance to take advantage building your credit history with a longer positive payment history, as well as building a longer average length of credit history.

Carefully consider your situation and your personal finance goals. If your plan is to save money in interest and get rid of debt sooner, paying off your loan early can make sense. If your goal is to boost your credit score, you might want to keep your installment loan a little longer before paying it off.

Image Credit: halfrain

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  • KatrinaR

    How long is necessary for “keeping your installment loan a little longer” to have positive impact on one’s credit w/ an otherwise good record?
    And does the benefit sort of level out/max at some point? say 5 years looks better than 3, but does 10 look much better than 7?

    • edwin

      its better to pay off most of the installment debt and leave like 20% outstanding, it really helps to boost up your score other than just paying it off full. Paid off my almost done car loan ($5k balance) really lower me 15 FICO score. I was so regret that i paid it off so early

      • KatrinaR

        Thanks, that’s what I was wondering about.
        In the end I did choose to pay mine off in it’s 7th year by paying double the min.
        I waited until after I got approved for my first mortgage. Then figured at that point if my credit gets dinged a little it didn’t matter as much, and the the peace of mind from less bills is worth more.

  • Montage Sociallyaware Authorof

    Capitalistic scamming

    • edwin

      its better to pay of most of the installment debt and leave like 20% outstanding, it really help to boost up your score other than just paying it off full. Paid off my almost done car loan ($5k balance) really lower me 15 FICO score. i am so regret that i paid it off so early