Why Did My Credit Score Go Down When I Paid Off My Car?
Understand the surprising reasons your credit score can dip after paying off an auto loan, and learn how it typically recovers.
Many find it surprising when their credit score decreases after paying off an auto loan. This seemingly counter-intuitive outcome often leads to confusion. Credit scores are complex and influenced by several factors, and the closure of a loan account can sometimes trigger a temporary adjustment. This article explains the reasons behind this common phenomenon, shedding light on how credit scoring models evaluate changes in your financial profile.
Understanding Credit Score Components
Credit scores are numerical representations of an individual’s creditworthiness, primarily used by lenders to assess risk. Various models calculate these scores, with FICO and VantageScore being the most widely recognized. These models consider several factors, each weighted differently, to determine a score.
Payment history, which indicates whether bills are paid on time, is often the most influential factor, typically accounting for about 35% of a FICO Score.
Another component is the amount owed, also known as credit utilization, which generally makes up around 30% of a FICO Score. This factor assesses how much credit is being used relative to the total available credit, particularly for revolving accounts like credit cards. A lower utilization ratio, ideally below 30%, is generally viewed favorably.
The length of credit history, accounting for approximately 15% of a FICO Score, considers the age of the oldest account, the newest account, and the average age of all accounts. A longer history of responsible credit management contributes positively to a score.
The credit mix, representing the diversity of credit accounts, contributes around 10% to a FICO Score. This factor evaluates a borrower’s ability to manage different types of credit, such as installment loans (like auto loans or mortgages) and revolving credit (like credit cards). A balanced mix can demonstrate broader credit management experience.
Finally, new credit, including recent applications and newly opened accounts, makes up the remaining 10% of the score. Too many new credit inquiries in a short period can signal increased risk and cause a temporary dip.
How Paying Off an Auto Loan Affects Your Score
When an auto loan is paid off, it can lead to a temporary dip in a credit score. The primary reason for this is the impact on your credit mix. Auto loans are installment credit with fixed payments. When such a loan is closed, it can reduce the diversity of your credit types. This reduction in credit mix, a relatively small factor (10% of a FICO Score), can contribute to a score decrease.
The closure of an auto loan can also affect the average age of your accounts. Credit scoring models consider the average age of all your open accounts. If the auto loan was an older account, its closure can shorten this average. While closed accounts in good standing may remain on your credit report for up to 10 years, their aging impact might diminish over time. This change in the length of credit history can negatively influence your score, as a longer history indicates more experience with credit.
Unlike revolving credit, where paying down a balance improves credit utilization, the payoff of an installment loan does not directly impact the credit utilization ratio, as installment loans are not part of that calculation. The closure of the account means it no longer contributes as an active tradeline. While paying off debt is a sound financial decision, the immediate consequence of an account closing can be a minor, short-term reduction in the score.
The Temporary Dip and Subsequent Recovery
Any credit score dip experienced after paying off an auto loan is typically temporary. Credit scores are dynamic and constantly adjust as new information is reported to credit bureaus. Creditors usually report account activity every 30 to 45 days, so it may take a month or two for changes to reflect. As positive payment history continues on other active accounts, the score tends to recover.
The long-term benefits of eliminating debt outweigh the short-term credit score fluctuation. The paid-off loan, assuming it had a positive payment history, will remain on your credit report for up to 10 years. Maintaining timely payments on all remaining accounts and keeping revolving credit utilization low are effective strategies for score recovery and long-term credit health.