How Much Does Your Credit Score Increase After Paying Off a Car?

The answer to this question is not always black and white, as different components come into consideration. Your thinking may be that paying your car off would increase your credit score immediately because you just paid off an account. However, because you are closing an account, you will see an initial drop in your credit score.

When referring back to the items that affect a credit score though, the payment history is going to eventually bring your credit score back up so long as you made payments on time. Additionally, when you apply for a new auto loan, this history will be advantageous. It shows lenders that you are reliable and there is less risk involved when lending to you. 

It is important to ensure that you do have a mix of credit. If your auto loan is the only main credit account you hold, and then you pay off your car, that will negatively impact your score. 

Look at paying off your car as an investment when it comes to your credit score. While it may seem like you have an initial drop, this drop is temporary. The fact that you have proof of reliability will benefit you more in the long run when applying for another account. 

What is a credit score?

A credit score is a number that represents an individual's creditworthiness and acts as a predictor for lenders of how likely you are to pay the loan back. This score helps lenders evaluate the risk associated with lending money or extending credit to an individual.

Credit scores are typically calculated based on information from a person's credit report, which includes details about their credit history, such as credit accounts, payment history, outstanding debts, and public records like bankruptcies or liens. The most commonly used credit scoring models are developed by companies like FICO (Fair Isaac Corporation) or VantageScore, and they assign a three-digit number to reflect an individual's creditworthiness.

Higher credit scores generally indicate lower credit risk, which can lead to better loan terms, lower interest rates, and a greater likelihood of approval. A lower credit score may result in higher interest rates or difficulties obtaining credit. 

For example, in FICO's scoring model, which ranges from 300 to 850, a higher score suggests a lower risk of defaulting on credit obligations. A good credit score is generally considered to be around 670 or higher, while excellent scores are typically above 800. 

When purchasing a car, your credit score is going to determine what kind of loan you have and how long it will be. If you have no credit or bad credit, there are alternative options. 

What affects credit scores to increase? 

Credit scores can fluctuate over time based on a person’s financial behavior. The following can affect a person’s credit score and are the components used to calculate your credit score.

Payment history

This makes up the majority of your score at 35%. Credit reports will show your credit history and whether you have consistently paid on time. The more consistent you are with paying installments on time, the higher your score. 

Credit utilization

Credit utilization accounts for 30% of your credit score. Credit utilization is the amount of credit you use represented by a percentage. Ideally you use no more than 30% of your available credit, which would result in a higher score. 

Credit history length

Credit scores take your oldest account, your newest account and the average of all your accounts. The longer your credit history, the higher your credit score. 

Mix of credit types

It is best to have a variety of accounts. These include installment accounts such as a car payment or mortgage and credit card amounts. 

Recent applications

If you have applied for new accounts, this could affect your score negatively. Too many accounts or inquiries can indicate increased risk. 

Considerations that are not taken into account to calculate your credit score include your race, color, religion, national origin, sex, and marital status, age, where you live, and checking your own score.

If you have lingering questions about paying off your car loan and your credit score, here are some answers. 

Should you pay off your car loan early?

This ultimately comes down to your interest rate. If you have a high interest rate and the ability to pay it off sooner, it is a good idea to pay the car off early. However, if you have a lower interest rate with payments that fit fine into your budget, it is better to focus on other financial goals such as building an emergency fund.

Either way, there is no benefit in regard to your credit score.  

Is there a penalty if I pay off my car early? 

If you have the ability to pay off your car early, be sure there is no prepayment penalty. Lenders occasionally include this stipulation in the contract from paying off your loan immediately. The penalty may be a percentage of the remaining loan balance or a specified number of months' worth of interest.

The purpose of a prepayment penalty is to discourage borrowers from refinancing or paying off the loan early, as it can be a financial burden to the borrower. It helps protect the lender's expected return on the loan by ensuring that the borrower fulfills the agreed-upon terms and provides a source of income for the lender.

Should I refinance my auto loan?

If you have a high interest rate, it may be worth approaching the lender to see if it is possible to refinance. This could result in lower payments which increases the likelihood of making payments on time, which will positively impact your payment history and increase your credit score.