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Although paying off your car loan is satisfying, it will not increase your credit score. Often, paying off your car loan will actually hurt your credit score.
Closing an active account may negatively affect some factors that influence your score. These factors may include your credit mix and the average age of the accounts in your credit history.
What Happens After You Pay Off Your Car Loan?
Paying off your car loan will mean that you should have more monthly cash flow. You can reallocate this money towards savings, pay off some other debts, and other options.
The information in your credit history is the basis for your three-digit credit score. Experian, Equifax, and TransUnion, the three main credit bureaus, compile your credit history.
The majority of lenders today use the FICO credit scoring model. FICO develops models that use formulas to calculate credit scores.
A car loan is an example of an installment loan, along with student loans, personal loans, and others. Another category is revolving credit accounts, most notably, credit cards.
Your credit mix is one of the factors used in FICO calculations. Having a mix of both installment and revolving accounts helps your FICO Score.
When you pay off a car loan, the account is no longer active. If the car loan was your only installment account, this will negatively impact your credit mix.
In the meanwhile, closing the car loan also might impact your average age of active (open) accounts. The negative effect is likely most dramatic if the car loan was your oldest active account.
Per FICO, many consumers without active installment loans maintain credit scores well above 700. Also check out our article, “Can I Get a Car Loan With a Credit Score of 600?” to see if it’s possible.
How Your Credit Score is Calculated
Did you know that you can have more than one credit score? First, variations exist when the data received by the three credit bureaus differs.
This occurs because not all lenders report to all three bureaus. Some lenders use a combined score based on the reports from all three credit bureaus.
As stated earlier, FICO is the largest and most widely used scoring model. Yet, a competing model known as VantageScore also exists.
The FICO and VantageScore models calculate scores using a similar set of criteria. Both models maintain compliance with the guidelines of the Equal Credit Opportunity Act (ECOA). The models differ slightly in the value or degree of influence applied to each set of criteria.
Both FICO and VantageScore also generate industry-specific scoring models. For example, models using formulas geared for auto lenders or credit card issuers.
The following five factors or categories are the basis for the FICO scoring model. Each has a percentage indicating its degree of influence or weight.
Payment History – 35%
Payment history is the largest individual factor influencing your score (35%). Your payment history reflects how you have managed your credit accounts over time.
Lenders make decisions based on a consumer’s likelihood of repaying their debts. They recognize the impor