Does Your Credit Score Suffer When You Pay Off A Loan Early?

Paid-offIn the world of personal finance, the credit score reigns supreme. Financial providers use it to determine whether you will handle credit properly, insurance companies use it to determine the risk of covering you, and some landlords use it to see if you qualify for an apartment. Because credit scores are so important, it is in your best interest to know how different financial decisions may affect your score. One decision that can impact your score is paying off a loan early.

How Credit Accounts Impact Your Credit Score

Let’s start with a brief explanation of how different credit accounts impact your score. There are five aspects that your credit score is built upon: payment history, debt utilization, length of credit history, new credit, and the types of credit used. A new loan will impact all five at once and lower your score until your first payment has been posted to the credit reporting agencies. Each payment after that will allow your score to grow by showing a history of on-time payments, utilization of an installment credit account, and, as the loan ages, the impact from opening a new account fades.

Credit cards boost or lower your score every month through on-time payments, length of credit history, and debt utilization. The key element here is your debt utilization ratio. If you carry a balance in excess of thirty percent of the credit limit on your cards, your score will suffer. If you maintain a balance that is less than thirty percent, your score will move higher.

Pay A Loan Off Early

Paying off a loan early can both hurt and help your credit score. The help is by lowering your overall debt utilization amount. Debt utilization accounts for nearly one-third of your credit score, so you can see a positive boost from lowering it to be sure. The boost is mainly created by having low credit card balances, not installment loans. The hindrance to your credit score will be in the length of your credit history. Once you pay off a loan, it no longer adds to that length.

One final thought to consider when you are kicking around the idea of paying off a loan early is: What are your future plans in regards to new loans? If you want to apply for any type of loan, lenders are going to look at your debt-to-income ratio or DTI. If your DTI is more than 35 percent of your gross monthly income, you will struggle to get the loan you want. Paying a loan off early will immediately lower your DTI; therefore boosting your future loan opportunities.

Personally, I am for paying off every loan early. This will keep your DTI at its lowest possible point and keep cash free when you need it. If you are worried about the length of your credit history, the best way to boost it is to obtain a credit card and keep that account open.

Can a Debt Collector Remove Data From Your Credit Report?

Some consumers suffer from the misconception that paying off an account that has gone to collections will improve their credit score. They hold that belief in part because they think that a debt collector is going to remove the negative account from their credit report once the debt is paid in full. Those consumers are most likely wrong on both points.

Collections And Your Credit Report

Whether a collections account is paid or unpaid, it will remain on your credit report for seven years, longer in some states. In some cases the damage is more severe if a debt collector obtained a court order to garnish your wages for the debt. The presence of a collections account means that you are a higher lending risk. There is good news: the damage to your credit score will fade with time.

So, if the account will remain on your credit report for seven years, should you bother paying off the debt or ignore it? There are two reasons to pay the debt. One is that paying off the debt does make you seem like slightly less of a lending risk. The second is that it removes the threat that a debt collector may take the issue to court and seek wage garnishment. In some states, placing a debt in front of the court resets the seven year clock for that debt to be on your credit report, damaging your credit score for even longer.

Is A Debt Collector Able To Remove Data From Your Credit Report?

At one time debt collectors would remove negative accounts from your report if you made it a condition of paying off the debt. That is no longer true. Debt collectors have the ability to do so, they choose not to. Debt collectors rely on the data provided by credit reporting agencies in order to determine which debts are the most collectible. Removing an account from your credit report would damage that source of information.

However, debt collectors recognize that improving your credit score is powerful leverage that can be used to get old debts paid. So, instead of removing data, they will often offer this: You pay the debt, then contest the debt with the credit reporting agencies. For their part, the debt collector will agree not to respond to the inquiry that will come from the agencies. In most cases, if the inquiry is not answered, the negative action will be removed by the credit reporting agencies. It is sort of the long way around, but your goal is still met.

Is It Worth The Aggravation?

Whether all of this is worth the time and aggravation depends on your financial goals. Are you planning to seek a large loan in the near future? If so, the lender will pull your credit reports. Seeing a debt in collection which still has a balance, the lender will factor the debt into your debt-to-income (DTI) ratio. With a high DTI you are very likely to be denied the line of credit that you are seeking.

How Long Does it Take to Pay off a Car?

Loan lengths are different, but the exact length of your loan was stated in the original loan contract as required by federal law. Loans may be 24, 36, 48, 60, 72, 84, or even 96 months. At the end of 2012, the average new car loan was over 60 months, so it took five years to pay off a car! Consumers typically opt for longer loan lengths in order to lower their monthly payments. This may seem great, but there are drawbacks, mainly that you will pay more in interest by the time you’ve paid off the loan. To find out how much more you will pay, have a look at our calculator. Additionally, a longer loan means you’ll face negative equity for a longer period.

Preparing for Your Loan

You do not have to take on a 60 month note if you are able to plan for a car loan. First, request your credit reports from the major agencies. You can get them for free at this link: Correct any errors that you find there. Next, you should look at this link ( to discover how FICO builds a credit score. After seeing how a credit score is built, you should address any areas where you are falling short. If you do not have a credit history or have poor credit, you can obtain a credit card to establish a history of on-time payments. If you are denied for ”normal” cards, try a secured credit card. Do not waste your time with a pre-paid or reloadable card. They are not reported to the major credit reporting agencies and will not boost your score. Once you have a card, charge $25 a month, then pay the entire balance in full less than 30 days later. Do that for six months and you will have a credit history and a history of on-time payments.

If you already have a credit card or still have a low score after obtaining one, then you may need to look for specialized financing. There are plenty of options on-line, so you may need to spend some time looking for the company that will offer you the most favorable terms. There are a few caveats that you need to be aware of. Specialized loans for low credit scores come with the cost of a higher interest rate and shorter loan lengths.

Investing in Classic Cars–Better Than Gold?

A classic car recently sold for $52 million. Of course, that was a 1963 Ferrari 250 GTO, one of only 39 in existence and had won the 1963 Tour de France road race. While that is an astronomical price for an extremely rare car, many people find themselves able to command high prices for their classic American (and Italian and German) steel these days.

Better than Gold…Really?

In fact, Historical Automobile Group International (HAGI), a research firm with expertise in classic cars, calls investing in classic cars “better than gold.” Their indices show that classic cars have outperformed not just gold, but art, wine, and stamps in the last decade, and HAGI has a very interesting graph comparing their top index to the S&P 500 from 1980 to 2008.

In total, classic car prices have doubled since 2008, and various sources have them up by 28-39% in 2013. This may sound like just another bubble, though industry insiders reiterate that because supply is so limited and finite–obviously someone can restore, but never build another 1963 Ferrari GTO–the market has a bright future, especially because there are so many more potential investors/owners than there are properties available.

Classic Cars for the Common Man?

At places like Pebble Beach in California and Amelia Island in Florida, the auction numbers are staggering, with 2013 sales-rates in excess of 90% and average prices in excess of $950,000. Obviously, such prices are beyond the reach of probably anyone who will ever read this article, the author included. However, there are segments of teh market that are very much in reach of the average investor. For instance, Hagerty has an index of the collectible cars priced below $30,000. This includes models such as the 1970 Chevy Camaro, 1965 Ford Mustang, 1972 Porsche 914 Targa, and 1967 VW Beetle–among others. The increased value of these cars since 2009 isn’t too shabby, with a 7.6% return-on-investment in less than five years.

  • April 2009:  $19,700 average value
  • December 2013:  $21,200 average value

Of course, unlike an investment like gold, vintage cars have additional costs. First you have the initial cost of the vehicle. Unless you buy a perfect example of the vehicle, you may have restoration costs–though there is certainly a market for unrestored examples. Still, you have maintenance costs, storage costs, insurance, etc. Additionally, if you intend to finance your purchase, you will have to do so through a specialty lender like JJ Best or Woodside Credit, so factor in interest paid.

On the other hand, most classic cars are not always restored and maintained with an eye to making a profit. They are simply bought for the emotional factor of owning a piece of history or a car from an owner’s youth. Classic cars may be a good investment from an emotional point of view, not just a financial one.