Getting rid of your car payment can definitely free up some cash every month, but it might hurt your credit score.
That might sound counterintuitive because paying off a car loan early seems like evidence of superior financial management.
But that’s not how credit scores work — they’re all about how you manage borrowed money.
Your car loan’s impact on your credit score
An auto loan is an installment account, or one with a level payment every month. Once your auto loan is repaid, you could lose points on your credit score, especially if you don’t have other installment accounts.
That’s because a factor in your credit score is called “credit mix,” or types of credit accounts. The best scores go to people who have installment loans, such as mortgages or car loans, as well as credit cards, known as revolving accounts. That shows you can manage both kinds of credit.
So paying off your car loan — or paying it off early — could actually result in your score dropping a bit.
How do I decide whether to pay it off early?
If you have the money to pay off your car loan early, and particularly if your interest rate is high, you might want to do it. But if you’re close to the end of the loan anyway and you won’t save meaningfully on interest, the main advantage to you may be psychological — knowing you owe no one for your ride.
If interest is a consideration, or paying it off early would deplete your emergency fund (or worse, you don’t have one yet), you may be better off keeping your auto loan.
But if your credit has improved, you can refinance the loan and save money — so long as you don’t extend the term when you do. (There is a case for extending the loan term, and that’s when your finances have changed and the old payment has become unmanageable. Extending the term will almost certainly increase the amount of interest you pay, and you are borrowing against something that’s dropping in value.)
Is there an upside to keeping a loan?
There can be an upside to keeping your car loan payment: for instance, you got a 0% financing deal. So paying it off early wouldn’t save you money, but you’ll continue to benefit from having on-time payments by keeping the loan.