Credit bureaus use five distinct categories to determine your credit score, which lenders use to determine your creditworthiness. Payment history, outstanding debt, length of credit history, new credit applications and types of credit are the five categories that determine consumer credit scores, and some categories carry more weight than others. The benefit of paying off debts such as car loans ahead of the amortization schedule depends on the other type of credit accounts you have and the amount of money you owe on those accounts.
Payment History And Length of Credit History
The length of credit history and your payment history combined account for 50 percent of your credit score. Making timely payments on your credit accounts is a key factor to boosting your credit score. In addition, continuing to pay long established counts not only shows that you have a good payment history for specific loans, but this shows that you have a track record of making timely payments across the board for all of your debts. So, if your car loan is one of your oldest credit accounts, paying of the loan will cause this portion of your credit score to decrease.
Credit Account Types
The type of credit or loan account you own make up 10 percent of your credit score. Banks and credit bureaus not only like to see a stellar payment history, but they also look for varied types of credit accounts. The reason being, if you can pay varying types of loans in a timely manner, this shows that you can handle all of your bills responsibly. Because car loans are paid in monthly installments, similar to mortgage loans, these accounts are considered installment accounts. If the only other type of debts you owe are non-installment accounts, paying off your car loan early could lead to a dip in your credit score.
Outstanding Debt
The outstanding amount of money you owe on credit accounts makes up 30 percent of your credit score. For this portion of your credit score, scoring models tend to assess how much you owe on a particular account in comparison with the account's credit limit. Since you can't borrow against your car loan continuously like a credit card, paying off your car loan early could boost this portion of your credit rating, especially if your total outstanding debt is considerably high.
Savings Considerations
If your car is old or in poor condition, or your car loan is your highest interest loan, paying of the debt early will help you save money. Using extra money to pay off your car loan early is comparable to investing the money at an interest rate similar to your car loan. In addition, paying off your car loan early can help you reduce the amount of insurance coverage required on for your car, saving you even more money. However, if you must pay your car loan off early, wait 12 to 24 months to capitalize on the credit amount on the account.
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