What Happens to Your Credit Score if You Pay Off a Loan?
The impact of paying off a loan on your credit score may surprise you.
Paying off a loan, whether it's an auto loan, a personal loan, or another type, is something to celebrate. That means you have one less monthly debt payment to work into your budget, and one less bill to worry about.
While paying off a loan is a positive thing, in some cases, it could actually have a negative impact on your credit score. Thankfully, though, that impact should be minor.
How paying off a loan might impact your credit
To understand why paying off a loan might hurt your credit, you need to know what goes into calculating a credit score. There are five factors, each of which carries a different amount of weight:
- Your payment history, which reflects how well you pay bills on time
- Your credit utilization ratio, which measures how much of your credit limit across all of your credit cards you're using at once
- The length of your credit history
- The number of credit accounts you've recently applied for
- Your credit mix, or the different types of accounts you have open
Of all of these factors, your payment history carries the most weight, followed by your credit utilization ratio. The length of your payment history falls in the middle, while recent credit accounts and credit mix carry the least amount of weight.
Paying off a shorter-term loan, like a car loan, shouldn't have a huge impact on the length of your credit history. But it could impact your credit mix -- namely, by leaving you with a less-healthy-looking mix.
Generally speaking, credit card debt is considered a relatively unhealthy type to have, even though plenty of consumers routinely carry a credit card balance. Now, let's say you've just paid off your vehicle and the only credit accounts left open in your name are a bunch of credit cards. Suddenly, that makes for a less balanced, healthy credit mix -- and so your credit score might take a hit once your car loan goes away.
To be clear, your score should only go down five points or so once a loan is paid off. That's because your credit mix carries less weight than other factors when calculating your score.
How to boost your credit score
Generally, you shouldn't sweat a minor hit to your credit score. But if you want to bring that number up, don't worry so much about your credit mix. Instead, focus on your payment history and utilization.
If you pay all of your incoming bills on time, that could help your score improve. If you want your score to rise quickly, try to pay off some of your existing credit card debt, as that could instantly shrink your utilization ratio, bringing your score up in the process.
Paying off a loan is a milestone to be happy about. Your credit score may take a small hit in the process, but that's just a quirk of how scores are calculated, and it's not something that should keep you up at night or cause you needless stress.
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