What will paying off my car loan do to my credit score?

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Q. I have a car loan that is due to be paid off in December. When the car loan is paid off, how much of a hit will my wife and I take on credit our scores?
— Borrower

A. Credit scores take multiple items into account.

You’re right to think paying off the car loan can impact your score for the worse. That might happen for one borrower and not for another, depending on your entire credit history.

Confusing, right?

Your scores are dependent on all of your debt, so it’s important to consider any other loans when estimating your score, said Jerry Corey, a certified financial planner with RegentAtlantic in Morristown.

That means credit card debt will impact your score differently than a car loan, he said.

There are five important components that make up your credit score.

Payment history makes up about 35 percent of your score, and the amount you owe makes up 30 percent. Your length of credit history is 15 percent, types of credit make up 10 percent and new credit activity makes up 10 percent.

Let’s look at what happens when you take out a car loan.

Corey said at the start, there is no payment history yet on the loan, so that component is not affected.

“The `amounts owed’ component, while you may think would negatively affect your scores since you are taking on debt, is closely tied to your revolving debt – credit card – utilization ratio,” he said. “The installment loan – the car loan – utilization ratio has a minimal impact on your credit scores.”

Plus, because this is a brand new loan, your average account length of credit history would be lower and you would have a new hard credit inquiry – counting for new credit, Corey said. Those would have negative impacts, but they would be minor, he said.

Finally, you’re adding a new type of loan to your history, so that would have a positive impact.

Now what about after you’ve had the loan for a few years?

Payment history, assuming you made all your payments on time, length of history, because time has passed, and new credit activity, because hard inquiries fall off your credit report after two years, would all positively affect your scores.

“One reason to think twice about paying an installment loan off early is to keep an active history of on-time payments, which continue to show the credit bureaus that you can manage and maintain your debt responsibly,” Corey said. “The fact that you pay off the loan is not a bad thing, as the loan’s history will stay on your credit report for at least seven years.”

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This story was originally published on May 20, 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.