Will paying off my car loan improve my credit score?

Article QuickTakes:

• Will taking out a car loan affect my credit score?
• Will paying off my car loan improve my credit score?

One of the first questions some car buyers ask is: “what credit score do I need to buy this car?” Not long afterward, they might also wonder: “How will financing a vehicle affect my existing credit score?”

Let’s explore the ways in which your credit could be affected as you complete your car buying journey.

Will taking out a car loan affect my credit score?

First, it’s important to understand the anatomy of the credit score. FICO, the company that calculates the most widely used credit scores on a scale of 300 to 850 points, considers these 5 key factors:

1. Payment history: 35%
   Making on-time payments is the most important aspect of your credit score.
2. Credit utilization: 30%
   This measures how much of your available credit you use. The optimal amount is between 5% and 30%. Carrying high balances on multiple accounts can indicate a higher risk of defaulting to lenders.
3. Length of credit history: 15%
   In general, the longer you have established credit with on-time payments, the better your score. But FICO looks at multiple indicators related to credit history.
4. New credit: 10%
   Establishing new credit can help improve your credit utilization ratio, but only open accounts as needed. Applying for multiple credit cards at once, for instance, can have an adverse effect on your score.
5. Credit mix: 10%
   Managing different kinds of credit, such as an auto loan and credit cards, can be a plus.

Taking out a car loan can have a few different effects on your credit score.

First, it will increase your total debt load, which may cause a slight drop in your score based on a new credit utilization ratio. And since you’ve just established this loan, there’s no payment history yet. But any slight decline in credit score should be remedied quickly if you make your first few auto loan payments on time. Payment history has the biggest impact on FICO scores.

An auto loan can also improve your credit mix , particularly if you didn’t already have an installment type account on your report. A diverse credit portfolio appeals to lenders, because it articulates that you have successfully managed different kinds of credit.

Will paying off my car loan improve my credit score?

If you pay down the balance of your auto loan over time, your credit utilization will go down, meaning your credit score may improve. And since making regular on-time payments is good for your credit, you’ll help maintain and possibly improve your score.

If you are considering paying off your loan early to save on interest fees, make sure your loan agreement doesn’t include penalties for that. Sometimes keeping the loan going a bit longer, with on-time payments, can have a positive impact on your credit score. Open lines of credit managed properly help establish a strong history.

On the flip side, if you find yourself struggling to make payments on time, it could be worthwhile to check if you’re eligible for a loan extension, which could provide temporary financial relief.

In any case, don’t be afraid to check your credit report regularly—doing so results in a soft inquiry that won’t hurt your credit at all. You are entitled to one free credit report per year from each of the three nationwide credit reporting bureaus (TransUnion, Experian, and Equifax).

Understanding how credit scores work and the impacts that buying a car will have on it will help you continue to improve your credit score.