Paying off a car loan can bring great emotional satisfaction, but most consumers have a practical question: whether paying off a car will translate to an improved credit score. Higher credit scores frequently lead to preferred interest rates and terms on home mortgages, so if you're looking to buy a home after paying off that car, it makes sense to check whether your scores are due to rise. If your car is paid off, there's a good chance that credit will improve.
Credit Components
Car payments represent just part of what's taken into consideration in factoring your credit score. The FICO score, created by the Fair Isaac Corporation, helps lenders determine the risk factor in doing business with you based on your previous financial decisions when handling credit. FICO scores range from 300 to 850; in general, scores over 720 are considered good and scores in the range of 500 or below are considered bad. Payment history represents 35 percent of your credit, amount owed represents 30 percent, length of credit history represents 15 percent, new credit reflects 10 percent and types of credit used represent 10 percent.
Significance
With that in mind, consider how paying off your car will affect your credit. Hopefully you've been making timely payments over the course of your auto loan, contributing to overall good credit. Having your car paid off may significantly reduce your total amount owed if you had a huge car loan and finished paying it off with a few lump sums; otherwise, your credit may have been steadily improving all along as the loan balance slowly diminished. In that case, don't expect a giant leap in credit improvement. If you've been making payments on the car loan for a number of years, this has probably positively contributed to overall credit as your lender relationship lengthened.
Other Factors
If paying off your car leaves you with extra cash in hand and you feel inspired to go on a shopping spree, racking up extra credit card debt or opening department store credit cards for celebratory purchases; beware. Remember that types of credit used represent 10 percent of your credit score. Installment loans (such as car loans, student loans and home mortgages) are considered better credit risks on your account than revolving credit, such as credit cards. Opening new credit cards after you've paid off your car may hurt your credit score, not improve it.
Report Rate
Another consideration is how fast that final car payment is reported to the credit bureaus. Lenders may take their time in reporting that you've paid off your car since they're more concerned with targeting delinquent accounts than giving you a gold star for repayment. Bureaus may have contracts with lenders that specify reporting timetables, but these may not be strictly enforced, since lenders are customers of the bureaus, according to Stason.org. If reported, it may show up in 30 to 45 days. If your credit report incorrectly shows that you still owe money on a car loan, then contact the bureau to fix this information.
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