Has anyone ever given you advice that turns out to be unhelpful or inaccurate? Well, we’ve been there, too. Paying off a car loan might be one of those situations where someone gives you advice that doesn’t help you in the long run.
For example, paying off your car loan might cause a dip in your score, but why? Aren’t we supposed to make our payments in full and on time? Why does our credit dip after we do this?
Many people have asked similar questions, such as, “I paid off my car loan and my credit score dropped. Why?” and “Does paying off a car loan help improve my credit?” We are here to answer these questions and more!
Why is your credit score dropping?
Knowing how credit scores are determined will help you better understand why your credit score may drop after you pay off a loan. To sum it up, your score is determined by your mix of credit, your utilization rate, your payment history, the length of your credit history, and any new lines of credit that you open.
These factors contribute different weights towards your credit score. For instance, your credit mix refers to having different types of credit on your report. So, by paying off an auto loan, you’ll end up minimizing your credit mix, which can decrease your score. For curiosity’s sake, check out the average car loan payment for each state here.
How car loans affect your credit score
From start to finish, auto loans are generally good for your credit score. If all of your payments are made on time, then your payments should, theoretically, build your credit score.
At the very beginning, when you apply for a loan, you will likely see a temporary dip in your credit score due to the hard inquiry that is applied when checking to see if you qualify for the loan. So, in the beginning, your score will be negatively impacted by the loan, though it’s a temporary drop.
Car loans are paid on a monthly basis, giving you an opportunity every month to show the credit bureaus that you are good with money. As long as you make your payments on time, your score should increase. These payments will show other lenders that you are in good standing with your current creditor.
As mentioned above, mixing your credit is important. If you only have one type of loan then this will not help boost your score as much as you might want it to. Institutions want to see that you can handle a variety of loan types, including auto loans, mortgages, credit cards, and personal loans.
When you add a car loan to the mix, then you’ll expand the contents of your credit mix and potentially see a rise in your credit score. This doesn’t mean you should open lines of credit just to have them, though. Think about these decisions before you make them.
Why would a credit score drop after paying off a loan?
Paying off a loan will immediately change your credit mix. The more variety there is in your credit mix, the better. By shrinking and consolidating your different types of debts, your credit score might dip. Did your credit score drop after paying off the loan? If so, we’ll explain why down below.
Scenarios that might cause a dip in your credit score
As the saying goes, you can fall down the stairs a lot faster than you can climb them. Similarly, it takes very little time for your score to decrease but it takes a lot of time for it to increase.
Car loan was an installment plan
Car loans are broken down into monthly payments, which can help you improve your credit score on a monthly basis. But if your monthly payments are not paid, the unpaid balances can have a negative impact on your credit score.
Loan took too long to pay off
Car loans have a distinct pay-off time frame. It can take anywhere from thirty-six to seventy-two months to pay off your loans. Sometimes, it takes even longer! But it all depends on your specific financial situation.
If you have a sixty-month loan but it takes you sixty-three months to pay off the loan, then your loan will be considered delinquent because you have not paid your monthly payments in full. You need to make sure that your monthly payments are not only being paid on time but that they are being paid in full as well.
Negative marks include late payments, defaults, and accounts in collections
Letting your payments become delinquent is a problem. It’s important to maintain consistent, on-time payments. If you cannot stay in good standing and make your payments on time, then your credit score will suffer.
You applied for another car loan
As we mentioned earlier, applying for a car loan will cause a temporary dip in your score. By applying for a loan, you are agreeing to a hard inquiry, and most inquiries will have a negative impact on your score, even if they are soft credit checks. Soft credit pulls may not last as long as the effects of hard credit pull, but they still cause your score to drop even if only by a few points.
6 ways to improve your credit score
- Make sure all of your current debt accounts have an updated status.
- Have a credit mix that contains a variety of loans.
- Ask your credit card companies to approve you for a higher credit limit
- Become an authorized user on an older credit account.
- Make on-time payments.
- Verify that your credit report is accurate.
Debt may help you out
Everything gets more expensive by the day. As such, many people need loans for almost anything of significance as a direct result of these increasing prices. However, your credit score will prevent you from borrowing money if your score is low.
Need help establishing or rebuild your credit score? Start with a MoneyLion Credit Builder loan. You could get up to $1000 with same-day funding and watch your credit score grow with our monthly credit bureau reporting. Not to mention, more than half our members raised their score by up to 27 points within 60 days!
Will my credit score go down after paying off the car loan?
There is a good possibility that your credit score will drop right after paying off your car loan.
Is it smart to pay off your car?
It depends on your financial situation. It might be smart to have as little debt as possible, but for others, paying off a car loan in a lump-sum payment could be more harmful than beneficial.
How much will my credit score go up if I pay off my car loan?
It depends. There is also a good chance that your score will dip once you pay off your car loan.