Credit scores confuse many people. We’ve talked recently about some things that can (and can’t) cause your credit score to increase or decrease. One of the questions that we see quite frequently however is whether or not credit scores can fall after paying off an installment loan, and why.
For example, we recently saw a question online that someone had asked about why their credit score had dropped 23 points directly after they paid off the installment loan on their car. This person was confused because their utilization rate had gone up slightly once the loan was paid off but nothing else had changed on the report. Still, their score dropped 23 points and left them baffled.
The simple fact is that, when it comes to your credit report, there really are no simple facts. Credit scores use incredibly complex algorithms that can be mystifying even to credit professionals. Trying to figure out what types of financial moves can affect your score can not only be confusing but, in some cases, counterintuitive. The reason is that it’s practically impossible to isolate a single factor that can influence your score when there are dozens of them.
In most cases paying off an installment loan like a car loan shouldn’t negatively affect a person’s credit score. Interestingly enough, it won’t boost a credit score very much either because most installment loans don’t actually lower a credit score in the first place. The one benefit that a person gets by paying off their installment loan is simply that they have a lower balance as the loan gets smaller.
Most people don’t realize that an installment loan actually stays on their credit report even after it’s been paid off, counting towards their mix of credit and the length of credit history that they have, both of which together account for 25% of their FICO credit score.
Of course another explanation is that someone may be comparing two completely different types of credit scores or that something else happened besides the fact that they paid off an installment loan. Amazingly, there are 53 different versions of FICO credit scores that can be used. Some of these are considered older generations that weigh certain factors on a different scale. Some have been tailored for different credit bureaus and these bureaus report differently because some lenders don’t report to all three of the Big 3 credit reporting agencies. Topping it all off are scores made to predict a person’s risk on specific loans like credit cards or automobiles.
Adding to the confusion is that all of these scores can be different from the others. Comparing two scores in most cases means absolutely nothing, like comparing apples to oranges or flatscreen TVs to bicycles.
Generally speaking, approximately 25% of people that pay off an installment loan will see their score go either up or down by 20 points. If that happens to be you the best advice that you can take is to keep paying down your debt and maintain low credit balances. If you are in a position that you don’t need to get new credit, more than likely any drop that your credit score experiences will right itself in a matter of weeks as long as your other financial habits are responsible and on track.
If you have any questions about credit, your credit score or personal finance questions in general, please let us know and will get back to you ASAP with advice, answers and solutions.