Installment Loans: If you are currently paying down a loan, chances are it’s an installment loan. It refers to any type of loan that is repaid via regular installments, or monthly payments, with interest included.
Your FICO credit score is a major factor that creditors look at when deciding if they’ll lend you money, and it’s generally broken down into the following:
Length of credit history
Types of credit
Insurance companies, banks, utility companies, and collection agencies might also check your credit score when making a decision, along with some entities that may come as a surprise.
When it comes to installment loans, the areas we’ll want to focus on the most are the amount owed, length of credit history, and prepayment penalties.
– Amount Owed
When you first pay off an installment loans, the “amount owed” goes down, which is good. But the account is now also closed, which reduces your available credit, and adjusts the type of credit you’re using.
– Length of Credit History
Keeping accounts in good standing for prolonged periods of time is a great way to increase your credit score over time. The problem, however, could be that your loan is tied to your oldest line of credit. That is when you finally pay it off, the account will be closed and you lose some length on your credit history.
You can rebuild your score over time, and by maintaining a healthy mix of revolving debt and installment debt, but it’s certainly worth having a heads up on the potential drop you’ll see when the account closes.
– Prepayment Penalties
Depending on the type of loan you have, there might be a prepayment penalty for paying your loan off early. This fine-print factor is an important one to consider both when opening the loan and closing out the loan.
Prepayment penalties should never keep you from making payments toward your debt, but could help determine whether or not to pay it off early or on a predetermined timeline.
FAQ’s About Payment of Installment Loans
– Does Paying-off a Car Loan Early Hurt Your Credit?
The primary reason paying off your car loan early could potentially hurt your credit score is if the loan contributes to an unbalance in your accounts of installment loans and revolving loans. Say, for example, your car loan is your only installment loan; you might see a dip in your score because the balance has shifted after paying off the loan.
– Does paying off a mortgage early hurt your credit?
Paying off your mortgage early likely won’t damage your credit, but it could end up costing you more than anticipated.
In fact, many lenders do have a prepayment penalty clause built into their agreements that’s worth asking about. This allows them to charge you a fee to help recoup some of the interest they would have earned had you kept your account open for longer.
If your mortgage is the only installment loan you have and you pay it off early, your score could drop by a few points, but it’s nothing to be overly concerned about. Just as when you took out the loan, most mortgages and installment loans don’t affect credit score when they’re fully paid off.
– Does paying off student loans early hurt your credit?
There are pros and cons to paying off student loans early. If you’ve made regular, on-time, payments toward your student loan debt, your score likely won’t drop.
The biggest benefit is freeing up the extra cash you’re paying toward your student loans and putting it toward another debt if you have one.
Another factor to consider is your interest rate. For example, if you owe $7,500 in student loan debt and your interest rate hovers around 2.8%, your annual interest would be nominal, around $250 per year, or about $20 per month, which wouldn’t necessarily be a strong candidate for paying off early if you have other more important expenses.
However, if you have a larger loan with a higher interest rate, the total cost of the loan might be enough motivation for you to prioritize paying it off early. Paying off student loan debt early won’t likely damage your score, but it won’t help it much either.
– 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.
– 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.