You finally paid off your car. Congratulations! But your excitement diminishes when you see that your credit score has actually dropped. What the heck? You wonder, “Why did my credit score drop when I paid off my car?”
Several factors can cause your credit score to decrease.
Do you have other credit cards or loans? Believe it or not, having multiple installment accounts can actually help your credit score if you make your payments regularly.
If your car payment was your only installment account, your credit score might drop after you pay off the loan because you don’t have other open accounts.
Did your car loan have a lower balance than your other debts? If you still have several high-balance debts after paying off your car loan, your credit score could take a hit. To avoid a drop in your credit score, you might want to consider paying down some of your higher-balance credit cards and loans instead of paying off your car first.
Have you recently applied for a credit card or loan? The drop in your credit score could be completely unrelated to paying off your car loan. Several other factors can cause your credit score to drop like applying for a new credit card or loan, making a late payment, or increasing the balance on your existing credit cards.
The decrease in your credit score might be temporary.
Even if your credit score drops after paying off your car loan, the decrease will likely be temporary. Paying off the loan doesn’t remove that account from your credit report.
The good news is that if you always made your payments on time and your account was in good standing when you closed it, it will have a positive impact on your credit history. After you close an account that's in good standing, it can stay on your credit report for up to 10 years.
However, if you missed or were late with your payments, your car loan could still have a negative impact on your credit scores even after you pay off the loan. Negative marks can remain on your credit report for up to seven years from the date of your first delinquency. The longer it takes you to pay the past due amount, the more negative hits get added to your credit report.
Paying off your car loan is a good thing.
Despite a possible dip in your credit score, paying off your car loan is still something to celebrate. The less debt you have, the better your financial health will be. Plus, you will have the extra money every month that you can spend on something else, like saving, investing, or paying off other debts.