Does It Hurt Your Credit to Pay Off an Auto Loan Early?

Maintaining good credit is an important part of your financial well-being. When a person finances a car, he usually does so with the intention of doing so over the course of a predetermined amount of time. Sometimes, after purchasing a car using a loan, a person may find himself in a position to pay of his car loan at a much earlier date. Paying off a car loan early can be a good idea, but you need to know how it may affect your credit before doing so.

Payments vs. Lump Sum

One of the best ways to pay off your loan so that it affects your credit positively is to make additional monthly payments that increase the amount of you are paying towards the loan's principal amount each month. You can also deposit the remainder of the loan into a defeasance account, which automatically credits the amount you want to go towards paying off the loan. Because your credit can improve each time you make a debt payment, both of these methods can help your credit score.

Lump Sum

You can also choose to make a lump sum payment to pay off the remainder of you auto loan. However, doing so may have a negative impact on your credit score. When a lender reviews a person's credit score to determine whether it should extend him credit, it looks at his credit history for information about his ability to manage long-term debt payments. If you pay off your car loan with a lump sum payment, particularly before a minimum of 12 months have passed, your car loan history will not provide the lender with relevant information.

Penalties

Before deciding how you want to pay off your car loan, you should first make sure that doing so does not incur additional fees or penalties. Loan rates are typically based on the anticipated retirement date of the loan, which includes interest accumulated over a specific period of time. As a result, lenders lose money, in the form of lost interest, each time a borrower pays of a loan before the agreed-upon date. While such savings benefits the borrower, lenders often charge opportunity cost fees to try to recoup lost income.

Credit Score

Paying off a loan early lowers a the total amount owes, thereby raising his credit score. Amounts owed make up 30 percent of your total credit score, so if your car loan is relatively high, paying it off early could significantly raise your overall score.