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Paying Off an Installment Loan Early: Will It Hurt Your Credit Score?

Are you currently working to pay off a loan? If so, it’s likely an installment loan, on which you make regular monthly principle-and-interest payments.

If you’ve been thinking about paying off your installment loan early, be sure to consider whether doing so can harm your credit score. The short answer is, “Yes, it can.”

How can that be? How can more debt be a good thing?

Well, think about the question every lender asks: Will you be able to make your monthly repayments? An open loan account with ongoing, timely payments is proof positive that you can manage your finances responsibly.

OK, so that’s the simple answer. But every financial question provokes subtle discrepancies. Let’s look at those more closely.

Installment Loans vs. Revolving Credit

The terms for installment loans vary widely. You can take out a loan with a repayment term as short as a few months or as long as 30 years.

A repayment schedule defines installment financing. The monthly payment typically is fixed with interest added. Notable exceptions are that some student loans require payments that increase in line with expected career advancement and salary increases. Mortgages, student loans, personal loans, and car loans all fall under the installment umbrella, and they’re part-and-parcel of life for most people today.

Revolving credit, by contrast, offers you the flexibility of making minimum monthly payments. Or you can make higher payments when you have the money to do so. Credit cards are the most common type of revolving credit. You might get more freedom for repayment than you do with an installation loan, but revolving credit is generally a more expensive way of borrowing.

So, while it’s clear that making regular, timely payments on installment loans can have a positive impact on your credit score, what if you have the finances to pay the entire loan off in one shot?

What Happens When You Repay a Loan In Full?

While it seems intuitive to assume that repaying debt early and closing your account with a lender would have a positive effect on your credit score, it’s not quite that simple.

For starters, only 15 percent of your credit score gets drawn from the number of loans you have.

Compounding the issue, fully 35% of your overall credit score is a reflection of your payment history. Making regular payments in line with an installment agreement is a surefire way to strengthen your credit.

Lenders like to see:

  • Longstanding accounts that you maintain per your agreement
  • A range of different types of credit
  • A documented history of making payments on time

Bear in mind that credit-reporting agencies consider both open and closed accounts when calculating your credit score. An open account with no delinquency exerts a more positive effect than a loan that you paid in full and closed.

Paying off credit cards early, on the other hand, is always a sound practice.

The Bottom Line

As with virtually everything related to credit scoring, there’s no precise answer that fits all circumstances.

If you have multiple installment loans, you’ll lose nothing by paying off one of them early. Continuing payments on the other loans will have a positive influence on your credit score, while you also benefit from no longer paying interest on at least one of your debts.

Your credit score is, indeed, a fickle creature.

Writer

Vivaan Marsh is a professional writer, editor and an expert in personal finance. Her career as a professional writer stretch for over 11 years. One of her passions in life is to help everyday families with there financial problems, making their life a bit easier and explaining complicated topics in an easy way. Read more >

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