Having a lot of debt is bad for your credit. However, paying off loans can also have an effect. Understanding how your loan payments impact your credit score will help you navigate how you pay off your debts.
Does the Type of Loan Matter?
Though several types of debts get reported to credit agencies, the different kinds of loans you might have will impact your score differently than, say, a credit card. This is because revolving credit vs installment credit affects your credit rating differently.
Since they will likely have the highest balances, your mortgage and car loan will make up much of your debt-to-income ratio. This means these loans account for most of the total credit you’ve taken on. Since your car note or home loan has a specific payback period, you make a monthly payment each month until you meet the loan terms, typically 15 or 30 years for most mortgages and anywhere from 3-7 years for a car payment. This differs from credit cards since those don’t have a repayment period but a spending limit.
As with any loan, making your payments on time is essential. If you’re over 30 days late, your credit report may show derogatory marks.
Does Paying a Loan Off Early Hurt Your Credit?
While paying loans off early may seem like a positive move, there are some things you should keep in mind. Your credit score might drop temporarily due to having an account paid off and closed due to these factors.
There might be prepayment penalties. Some contracts might include a clause that charges you for paying off the loan in full before the full term. It’s crucial to weigh the interest you’d pay vs the prepayment penalty to see if paying it off early is in your best interest. If not, ensuring all future payments are made on time is vital.
Paying off a loan will affect your credit history and credit mix. Having an account paid in full and closed before it’s due means it won’t have a long history, and the average age of your accounts will be lower. Similarly, paying off a loan will affect your credit mix because you’ll have less variety in the types of accounts on your credit report.
3 Reasons to Pay a Loan Off Early
However, there are still potential upsides to paying a loan off early. The slight dip in your credit score might be outweighed by the benefits you might reap.
- It can save you money on high interest rates.
- It reduces your debt-to-income ratio.
- It reduces your total debt load, lowering your credit utilization ratio.
Why Does Your Credit Score Drop After Paying off a Loan?
Your credit score is comprised of various factors, such as the age and variety of your accounts, payment history, and how much credit you’re using.
Paying off a loan early impacts several of these factors, which means your credit score might be impacted. Typically, these drops are temporary, and your score will recover quickly.
It’s worth noting that paying off a loan is not the only way your score can be impacted. As stated above, missing or late payments will be reported to the credit agencies after 30 days. Therefore in an effort to maintain your credit rating, it’s essential to make all your loan payments on time.
How Closed Accounts Continue to Impact Credit Scores
Even a closed account can affect your credit score. If you made all your payments on time, this will be factored into your payment history. This is one of the most significant factors that go into calculating your total score, so having a positive payment history on an account will continue to have an impact even after it’s closed.
What About Personal Loans?
Applying for and getting approved for a personal loan will impact your score in a similar fashion to the other types of loans we’ve discussed.
Adding this kind of debt to your credit report will count as another account for the credit reporting agencies to factor into your credit mix and utilization. The importance of making on-time payments extends to personal loans as well.
However, how you use a personal loan can have a different impact. For example, suppose you’re using it as a form of debt consolidation. In that case, it may help improve your score by reducing your credit utilization ratio and saving you money on high-interest credit cards.
If your credit score has suffered but you need extra cash, our bad credit loans are here for you!
Contact Balance Credit today to explore our loan options and start your application process.
*The information contained in this post is for general educational and informational purposes only. It is not an offer of credit, does not fully describe the products that we offer or facilitate, and it is not specific to any individual. These products are an expensive form of credit, and you should ensure that they meet your unique financial needs. We are not a credit repair organization and make no representation that we or any loan will improve or attempt to improve your credit rating. We do not provide financial advice or assistance regarding your credit situation. These educational posts are not a substitute for individualized professional advice.
