Does Paying Off a Car Loan Early Help or Hurt Your Credit?

Transparency disclosure

• About this guide: St Pete Mitsubishi is a car dealership, and we earn money when customers finance vehicles with us. We've written this guide to be accurate and useful whether or not you buy from us — including the parts that suggest waiting, saving more, or spending less. Written by St Pete Mitsubishi

Paying off an auto loan ahead of schedule is mostly a smart move, but wiping out that balance ahead of schedule can impact your credit profile in unexpected ways. In fact, it can sometimes cause a temporary dip in your credit scores, depending on the rest of your history.

• Closing a car loan can temporarily lower your credit score.
• On the other hand, eliminating your loan frees up cash flow, reduces interest charges, and lowers your debt-to-income ratio.
• Check your contract for prepayment penalties before you decide to pay off a car loan.

If you pay off your only car loan, you close out your only installment account. That leaves you with nothing but credit cards on your record, which narrows your credit mix and can cause your score to drop. Scoring models view individuals who successfully manage installment debt as less risky.

Your numbers will recover as you continue paying your other bills on time. If you do not plan to apply for new financing or mortgages in the near future, this temporary dip will not impact your financial life anyway.

If your budget allows for it, clearing the loan cuts down on the total interest charges, keeping more money in your pocket over the lifespan of the vehicle. That freed-up money can go toward savings or other financial goals.

Getting rid of that monthly car payment also drops your debt-to-income ratio, making it much easier to get approved for better interest rates for another loan down the road. Plus, because vehicles lose value fast, paying the balance off early ensures you never have to worry about owing more than the car is worth.

An early auto loan payoff does not always make sense. Some lenders include a prepayment penalty in the loan contract. If your lender charges a fee for closing the account early, you need to calculate whether the interest savings outweigh the penalty.

If you carry credit card debt or personal loans with high interest rates, you'll save far more money by wiping those out before touching a lower-interest auto loan. Additionally, you should never deplete your liquid cash to pay off a car if you have not built a solid emergency fund first. Finally, because closing the account can trigger a temporary drop in your credit score, you should avoid paying it off right before applying for a mortgage or another major line of credit.

If you decide that paying off the vehicle early fits your goals, you can approach it in a few different ways. If you have a chunk of savings set aside, you can request a final payoff quote from your lender and eliminate the debt with a single lump-sum payment.

A gradual but faster way to pay off your loan early is to add extra money to your minimum payment each month or to make additional payments whenever you have extra cash. Another alternative is refinancing your current auto loan to secure a lower interest rate or a shorter repayment term, which allows you to clear the principal much faster.

Deciding whether to pay your auto loan off early depends heavily on your unique financial situation and future buying plans. If you want to review your specific loan terms, calculate your potential interest savings, or figure out how an early payoff will impact future credit applications, contact us today to walk through your options.

• Financing information: Financing is provided by third-party lenders, not by St. Pete Mitsubishi. Approval, annual percentage rate (APR), down payment, and loan terms are determined by the lender based on your credit history, income, the vehicle, and other factors. Not all applicants will qualify, and no approval is guaranteed. Rates and terms vary and are subject to change. Contact us for terms that may be available to you.

• This article is general information, not legal, financial, or credit advice. Every situation is different, and nothing here is a recommendation about your specific circumstances. Rates, lender requirements, and regulations change frequently, and the information here may not reflect current terms. Verify details with the lender before making a financing decision, and consider speaking with a qualified financial or legal professional. [Dealership] is not a lender, a credit counselor, or a law firm.