Will a Car Payment Affect My Credit Score?

Will a Car Payment Affect My Credit Score?

If getting rid of a car payment is at the top of your agenda, you may need to think about it with respect to your credit score as well. It will free up your cash but may hurt your credit score. Although it sounds counterintuitive, you need to consider the broader perspective. It’s about the way you can manage your borrowed money.

Anatomy of a Credit Score

Before understanding the impact of car payments on credit scores, you should know what exactly a credit score is. It is a parameter used by FICO that measures credit scores on a scale of 300-850 points made up of the following factors.

  • Payment history constitutes 35% of your credit score. Hence, make your payments on time.

  • Credit utilization makes up 30% of your credit score and measures the amount of available credit used by you. You should maintain a steady balance on multiple accounts to improve this point.

  • Length of your credit history makes up 15% of your score. Here, you get better scores if you can establish credit for a longer time with on-time payments.

  • New credit is 10% of your score.

  • Credit mix with different kinds of credit is also 10% of your score.

How Does a Car Loan Affect Credit Score?

A car loan is an installment-based system where you make a level payment each month. Once you repay your car loan, you can lose some points on your credit score if you don’t have any other installment going on. It is due to a factor called credit mix. It refers to the types of credit accounts you own. They may include mortgages, credit cards and car loans. If you can manage all of them well, it improves your credit scores.

When you apply for a car loan, it reduces your credit utilization and increases your score. When you start paying it off, it increases the credit utilization but reduces the credit scores by a bit until the loan is paid off.

Should You Pay Off Your Car Loan Early?

If you have excess money to pay off your car loan, you might do it. However, try this strategy when the interest rates are high. But, if you want to close the loan when it is already nearing the end, there is no substantial advantage. When interest is a major consideration and early payments will affect your emergency funds, it is better to continue your car loan.

You can refinance the loan and save more money if your credit scores are high. But, you shouldn’t extend the term of a loan. You should also pay attention to your loan agreement if you intend to make early payments. There should be no penalties on early payments in the agreement. If you keep the loan ongoing for a longer period with timely payments, it will have a positive effect on your credit ratings. Open lines of good credit management create a strong history.

Impact of Late Payments on Credit Scores

If you find it difficult to make car payments on time, you should check your eligibility for a loan extension. This condition can have a negative impact on your credit score. Check your credit reports regularly to keep an eye on your standing.