Here’s What Paying Off a Loan Means for Your Credit Scores

Your credit score is an important figure lenders look to determine if you’re a responsible borrower. It helps determine your approval chances for loans and credit cards, and can help you qualify for lower interest rates. It may also be used to decide your eligibility to rent an apartment or home.

Making regular on-time payments on a loan can help build your credit quickly, especially since your payment history is the larger factor credit agencies look at when setting your credit score. But what happens to your credit after you pay off a loan?

Does paying off a loan build credit?

Paying down a loan over time can help positively benefit yourcredit score in two ways. First, it helps establish a history of making on-time payments — a key signal lenders look for when loaning money to borrowers. It also adds to your credit mix, by adding another type of credit to your profile.

When you pay a loan off and eliminate your debt, you may think your credit score would increase. And while paying off debt is good for your credit profile in the long run, you should expect your score to drop slightly after paying your debt down — especially if you're paying off your only loan.

Once your loan payments are no longer active on your credit report, your score might drop temporarily since your credit mix might decrease. But continuing to practice healthy habits — like paying down your other accounts and credit cards on time each month, will quickly help your score rebound.

What happens to your credit if you pay off a loan early?

If you have enough money to pay off a loan, you may want to pay it off early. While this may be a smart move for your finances, here are some pros and cons to consider:

Pros

• Less debt hanging over your head. The real benefit is obvious — you’re eliminating debt sooner, so you can focus on other financial goals. This can be a huge milestone emotionally, and worth considering if your debt has held you back in the past. Paying off a loan early can lighten the load you carry and can also allow you to seek out other personal loans and additional financial opportunities.

• You can put money towards other debt. If the loan you’re ready to pay off is only part of your debt, paying off one account early can help you shift gears to focus on your next debt. Your credit score will increase and you will also have more financial options available to you. The impact on your credit history will have short and long term benefits and can increase your credit accounts standing and improve your credit scores over time.

• You could save on interest. Depending on your loan terms, you mightsave on interest if you pay off your loan sooner. This isn’t always the case, though. So it is important to consider the short and long term effects of paying off a loan early can have on your credit score and credit history. Saving interest charges and improving your credit accounts standing is a win but you will have to consider some of the disadvantages of paying off a loan as well.

Cons:

• Your credit mix may decrease. If you only have one loan, paying it off early is likely to ding your credit score in the short-term, since you’ll have less of a mix of credit on your credit report. Paying off a loan will affect your credit history and history length which can lower your score at first. But over time it can improve your credit score and show you are responsible and can manage your credit accounts.

• You’ll have no or fewer monthly payments reported. Making on-time payments on a loan or credit account each month helps demonstrate you’re a responsible credit user. With no or fewer monthly payments showing up on your credit report, your score might drop slightly. Debt payoff can have a ripple effect and cause a credit score drop with the credit bureaus. It affects your debt to income ratio in the short and long term.

• You might be hit with an early-repayment fee. Some lenders charge you if you pay off a loan early, especially if they’ll miss out on interest. Be sure to check your loan terms before paying off the rest of your debt. Then you will know if the temporary credit score drop is worthwhile and if your payment history will still be strong with your debt to income ratio now different. The impact on credit scores is always worth considering.

Pay off debt early or continue making payments?

Whether or not you decide to pay off your loan early is a personal choice that you’ll want to make on your own. If you want to keep the money you’ve saved to pay off your loan in a high-yield savings account, you can continue making regular payments, while earning interest on your money. Paying off a loan is something that only the loan holder themselves can decide.

But if you think you’ll be tempted to spend this money or have other debts to focus on, paying off the loan may be a smart move. If you can properly manage your loans and protect your credit score then you can pay off a loan and then use that momentum to get another personal loan or other line of credit you can use again. When you can properly manage your debt and keep up with payment history and avoid missed payments and manage your loans you can let that work to improve your credit score.

Other ways to improve your credit score

After paying off a loan early, you’ll want to ensure you continue to work on your credit.

1. Pay bills on time: The most crucial factor in building credit is making timely payments so be sure to set up automatic payments or reminders to ensure bills are paid by their due dates.

2. Keep credit card balances low: Aim to use a small portion of your available credit—ideally below 30%. High credit utilization can negatively impact your score.

3. Diversify credit types: Having a mix of credit accounts can positively impact your score, but you should space them out and manage them responsibly.

4. Become an authorized user: If a family member or friend has a good credit history, becoming an authorized user on their credit card can help build your credit.

5. Check for errors on your credit report: Regularly review your credit report for any inaccuracies that might be dragging your score down and dispute errors with credit bureaus.

6. Apply for a secured credit card: If you're having trouble getting approved for a traditional credit card, asecured credit card backed by a security deposit can help you build credit.

7. Limit new credit applications: Each hard inquiry into your credit can lower your score temporarily but try to avoid multiple inquiries within a short period.

8. Regularly monitor your credit score: Many credit card companies offer free access to your credit score. Monitoring it regularly helps you track your progress and catch any issues early.

9. Keep old accounts open: Even if you're not actively using an old credit card, keeping it open can positively impact your credit score by increasing the average age of your accounts.

10. Pay twice a month: If possible, make bi-weekly payments on your credit cards. This can help keep your credit utilization low throughout the month, even if you're using the card regularly.

11. Apply for a credit builder loan: Some banks and credit unions offer credit builder loans designed to help individuals build credit with easier terms.

12. Use experian boost or similar services: Services like Experian Boost allow you to add utility and telecom bill payments to your credit report to boost your credit history.

13. Avoid closing accounts frequently: Closing accounts can reduce your available credit and, consequently, increase your credit utilization ratio so try to keep accounts open if possible.

14. Consider other types of loans: personal loans, an installment loan, lines of credit, and other credit report items can all work together to boost your credit score rating and credit limit.

15. Seek professional help: If your credit situation is complex or you're struggling with debt, consider consulting a credit counseling agency or a financial advisor for personalized guidance.

Lenders use your credit score as a crucial metric to assess your reliability as a borrower and will compare your credit score with the scores of others to see how you compare. This figure significantly influences your likelihood of loan and credit card approvals, as well as the potential for securing lower interest rates. Additionally, it may impact your eligibility for renting a home or apartment and how your credit score will rise and fall over time.

Building your credit swiftly is achievable by consistently making timely payments on a loan. Your payment history holds significant weight when credit agencies calculate your credit score, making it a pivotal factor in boosting your credit score rapidly.

KOHO Credit Building options

Regardless of your credit score, if you want to work on boosting your credit and start showing lenders you manage money responsibly, consider a KOHO credit building subscription.

KOHO’s line of credit offers can help you easily establish on-time, affordable payments each month, to keep you out of debt while growing your credit score.

You can get started athttps://www.koho.ca/credit-building/.