Eliminating your monthly car payment will unquestionably free up some cash for you each month, but it might have a negative impact on your credit score. This is because open accounts with a strong record of on-time payments significantly impact a person's credit score. When you close an account, you may also see a reduction in the credit mix and the average age of your accounts. Here is what you need to know about the potential impact on your credit score that paying off your car loan early might have.

Your Car Loan's Impact on Credit Score

It is helpful to understand how credit scores are calculated since these ratings are based entirely on how well you handle money that has been borrowed. Building a positive payment history, the most important factor in determining credit ratings, requires consistent on-time bill payments. When you close the account, it will no longer contribute to your payment history in any active capacity.

A vehicle loan is an installment account, which means that it has a predetermined repayment schedule and a consistent monthly payment amount. Because "credit mix" is another component of your credit score, you might suffer a drop in points if you do not have any other installment accounts after you have paid off your loan. Your credit score might also be affected by the average age of your open accounts. People with a lengthy track record of making payments on time for installment loans and credit cards are rewarded with the highest ratings. Therefore, paying off your car loan completely or early could result in a little decrease in your credit score.

How Do I Determine Whether Or Not To Make An Early Payment?

It can be advantageous to pay off your car loan early if you have the means to do so, especially if the interest rate you are paying is excessive. Before you make a financial commitment, give some attention to where you are about other financial objectives, such as establishing an emergency fund. Consider whether or not a loan for a car counts as a positive or negative kind of debt.

If you decide not to pay off your loan early but are concerned about paying a high-interest rate, you can reduce your monthly payments by refinancing your vehicle loan. When you refinance your mortgage, you should avoid extending the term unless your financial situation has significantly altered and the previous cost of payment has grown unmanageable. Extending loan term will likely increase the interest you are responsible for paying back.

Is There An Upside To Keeping A Loan?

There are situations where continuing to make payments on a car loan might be advantageous, such as when the terms of the financing offer are interest-free. Therefore, paying it off early will not save you money, but maintaining the loan will allow you to profit from making on-time payments for as long as you have it.

What's the Right Decision?

Everything may be reduced to the sum of the parts discussed up to this point. When deciding whether or not to prepay a loan, it's important to think about several factors, including credit score, the amount of interest you'd save versus how much you're currently paying, your other expenses (both now and in the future), the existence of any prepayment penalties, and the status of any pending mortgage applications.

You also can switch from a vehicle loan with a high-interest rate to one with a reduced overall interest rate. You can lower your payments by refinancing your auto loan if credit score has increased since you purchased the car or if interest rates have dropped significantly since that time. Credit score will improve as long as you are on time with your monthly payments.

When to Pay Your Car Loan Off Early

There are circumstances in which paying off your car loan ahead of schedule might be beneficial, even though doing so can have a negative impact on your credit score.

• If paying off your car loan will be fine with your ability to reach your other financial objectives, you should do so. You should prioritize either accumulating money for an unexpected need or paying off debt with a high-interest rate.
• Paying off your car loan early is a smart idea for several reasons, one of which is to bring down a high debt-to-income ratio. If your debt-to-income ratio is near or above 50 percent, it will be difficult for you to get further financing from financial institutions. Your loan-to-income ratio (DTI) will go down due to paying off your car loan, making it simpler for you to qualify for other loans, credit cards, and a mortgage.
• Last but not least, paying off your car loan early enables you to free up cash that may be used toward increasing your savings, accumulating wealth via investments, or launching a company of your own. However, if your lender levies prepayment penalties, you will need to calculate the whole cost of the transaction before deciding whether or not it is prudent.