02 Apr What paying off a car loan means for your credit score

Q. I have a car loan that is due to be paid off next month. We’re thinking of trading in the car shortly thereafter. If I wait until the loan is paid off, how much of a hit will I take on my credit score.
— Driver

A. If your car loan is your only installment loan, you could see a dip in your score.

Here’s why.

There are five primary factors that affect your credit score.

The most significant factor in determining your score is bill payment history, which accounts for 35 percent of your score. This shows how timely you have been with paying your bills over the years and whether or not you have had any significant negative events like a bankruptcy, foreclosure, or tax lien, said Charles Pawlik, a certified financial planner and chartered financial analyst with Beacon Trust in Morristown.

The second most impactful factor in determining your score is your overall debt level, which shows the level of your loan balances relative to the original loan amount and the ratio of your credit card balances to your credit limits, Pawlik said. This makes up 30 percent of your score.

Your credit history age makes up 15 percent of your score, the number of credit inquiries you have accounts for 10 percent, and the remaining 10 percent is based on the types of credit you have, Pawlik said.

That’s where paying off a car loan fits in.

Your mix of credit types focuses on what kids of debt you have, and there are two broad categories: installment loans and revolving credit.

“Installment loans are loans that are repaid over time based on a set number of scheduled payments and include car loans, mortgages, student loans, and personal loans,” Pawlik said. “Revolving credit is essentially a credit line of a certain amount that is extended to you that you can draw on as needed, such as a credit card.”

Having both types of accounts on your credit report and in good standing is better for your score because it indicates that you have experience effectively managing various types of debt, Pawlik said.

For example, if you have a car loan, a mortgage, a student loan, and a long-standing credit card in good standing/with good payment history, this is looked upon favorably in terms of your ability to manage different kinds of debt, he said.

This factor accounts for 10 percent of your overall credit score, so paying off a car loan that was in good standing should not adversely impact your credit score in a meaningful way, particularly if you have other installment debt such as a mortgage or personal loan paired with long-standing credit card accounts that are in good standing,” he said.

If the car loan is your only installment loan, you may see a bigger difference, but your score will move back up over a short period of time if your other credit use is on track.

Remember you’re entitled to receive a free copy of your credit report every 12 months from each of the major credit reporting agencies, and you can get that from AnnualCreditReport.com.

Also note, Pawlik said, that many credit companies offer credit simulators so that you can get a sense of the potential impact on your credit score when the various factors that impact your credit change, such as paying off a loan, Pawlik said.

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This story was originally published on April 2, 2019.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.