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How Will Paying Off a Loan Early Affect Your Credit?

Credit plays a huge part in your financial health; because of this it is no mystery why people strive to constantly increase their credit score. One strategy that many people use to build up their credit score is to pay off all of their credit card debt. This can substantially increase credit scores, especially if the credit card debt paid down is a large amount.  Because of this, it may seem intuitive that paying a car loan or home loan early will increase your credit score, however this isn’t the case. In fact, keeping an installment loan open can in fact be good for your credit score.

Loan vs. Credit Cards

Credit cards are considered a revolving account. This means that they contain a revolving balance each month. Because of this, even if you pay down your credit card balance, your credit card account will stay open. However, installment loans are a very different animal. Installment loans are a type of loan that has a set amount of payments that are scheduled at a specific time. Every time you make a scheduled payment you are fulfilling a part of your loan obligation, and once you have made all of your loan payments the account closes.

Loan’s Impact on Credit Scores

Paying off an installment loan is in fact good for your credit score; however it does not have as big of an impact as paying off credit card debt due to the fact that the amount of debt contained in an installment account is not considered a huge factor in your credit score. That being said how you use your credit is. In fact, there are a number of ways that paying off your installment loan will affect your credit score.

Closing an Account

The number of account that you have open impacts your credit score. When you fully pay off an installment loan you have one less account that is open, which will increase your credit score.

Keeping an Account Open

It may surprise you that credit scores are actually increased when you have a few types of different credit accounts open. These include student loans, car loans, mortgages and credit cards. This is because it shows that you can manage multiple types of credit. On top of this, credit scores love when you have an aged account and long credit histories. Due to this, closing an account, especially if it has been open for a while can also negatively impact your credit score.

Paying an Loan Early

If you are considering paying off an installment loan ahead of schedule then you should think again. This is due to the fact that credit score’s prefer to see active accounts that are open and have a long history of timely payments. Although paying down an installment loan ahead of schedule will likely not hurt your credit score, it is important to keep in mind that leaving an account open and carefully managing it by following the terms of your loan can in fact be better for your credit score.

The Bottom Line

Paying off an installment loan and getting rid of debt, especially a loan that you have been paying off on schedule for a long period of time is good for your financial well-being due to the fact that it is a chip off of your shoulder and means you have less interest to pay. However, if you are thinking about paying off a loan early solely to increase your credit score then you should reconsider, as this will likely work against you.