If you’ve become a credit score junkie, then you understand the fever. You check your score incessantly. You work hard to pay all of your bills on time. You send letters to the three major credit bureaus to correct errors and past transgressions.
And you most likely look for big ways to improve your score. Perhaps that’s why you’ve clicked on this article? Maybe you’re toying with the idea of paying off a loan early, but you don’t know how the process works?
Heck, you may question whether paying off loans early will actually prove advantageous to you in the long run. And these are questions you absolutely should ask.
So, can you pay off a loan early without consequences and still enjoy credit score-raising benefits? Read on for a full breakdown of how early loan repayment works.
Know Your Loan Type
Loans come in different types with different restrictions. Since they’re not all created equal, whether or not to pay off each type will differ.
Loan types include:
- Installment loans
- Credit card loans
- Property mortgages
- Car loans
- Student loans
But you need to understand a few things about each type before ramping up your monthly payments.
For example, paying off an installment loan too early won’t do much for your credit score. What’s more, if you then close out the account early, you’ll lose most of the benefit possible from an installment loan.
Why? Installment loans don’t have as significant an impact on your score.
But you know what does look great to creditors? Seeing you make on-time payments over the full course of the installment loan term.
Credit Card Loans
On the other hand, paying off credit cards loans will provide your credit score with a healthy shot in the arm. That’s because credit card loans are considered revolving credit. That means the balance revolves from month to month.
When you pay a revolving loan off and maintain a zero balance, you’ll be amazed by how your score skyrockets. What’s more, the higher the balance on a given card, the more it will help your overall credit score.
Property mortgages are considered installment loans. So, some of the advice above applies to them.
But here’s where the water gets dicey. Depending on the type of mortgage that you have, paying off your mortgage early could actually put a big, painful dent in your pocketbook.
Why? Because some home mortgage terms include penalties for early payment. So, before committing to extra payments or more money per payment, speak with your mortgage lender to make sure you won’t be penalized.
When it comes to paying off a car loan early, contact the bank that holds your car title. Make sure no early payment penalties will apply.
As for actually paying off the loan, you have a few options. You can make more payments or make larger payments each year to shorten the term of your loan.
Or, you can think smaller but still see big results. For example, by simply adding $50 per month to each payment, you can shave a few months off of your loan.
Whichever payment method you choose, make sure you specify that the amount goes towards the principal, not the interest.
That said, like home mortgages, car loans represent a type of installment loan. So, you may see more financial advantage from riding them out. (No pun intended.)
Student loans are the bane of every graduating college student’s life for many reasons. At one of the most financially vulnerable periods of your life, they represent a terrible, albeit necessary, burden to bear.
Besides feeling like a dark financial cloud constantly hanging over your head, student loans can limit your ability to get a loan or even buy a home.
So, what happens when you land that dream job and can finally start paying down your debt? Should you take the financial leap?
While paying off your student loan early won’t hurt your credit, continuing to pay your installments over the full term of the loan represents your better option.
Like other installment loans, this demonstrates to creditors that you are responsible. It sets a precedent for timely payments in the future and reassures creditors and bankers that you’re somebody they want to work with.
That said, if it’s keeping you from buying a home, then an early pay-off may prove your best option.
A Caveat: Think Before You Close
Having a diverse collection of loans (although not too many!) shows creditors that you’re able to effectively manage different loan types. But they’ll also take a look at the length of your credit history.
So, before you start paying off loans and closing accounts, keep this in mind. You need a long credit history to satisfy many creditors.
In other words, even though you think paying off and being done with a loan will improve your score, it may actually hurt it… If you close the account.
Can You Pay Off a Loan Early? Here’s the Bottom Line
Eliminating debt tends to do wonders for your credit score. But remember that it’s ultimately an indicator to creditors or how great a customer you would be to work with.
So, in some instances, as with an installment loan, you’ll demonstrate more by paying your loan on time over the full term. This advice holds true for student loans as well.
But you should definitely tackle credit card loans, which involve revolving credit, before diving into other early payoffs.
And as for home mortgages? It all depends on the type of loan you have and whether or not early payment penalties exist.
Do a little research before you come up with a solid plan for getting out of debt and into a better economic position. Credit scoring isn’t always as clear cut as it seems.
By doing a little homework, however, you can rock the system and ramp up your score.
Take Back Your Score and Your Life
A bad credit score is a real drag. It impacts every aspect of your life, from what car you drive to where you live. And if you’re already monitoring it like crazy, then you know how difficult raising it can be.
“Can you pay off a loan early?” represents just one of many financial questions that you may have as you work to take your score and your life back. Fortunately, you don’t have to go it alone.
We’re here to help. Visit our resource center now to learn more about the financial options that you have and how Bonsai Finance Resources can help you get on the fast track to a better credit score.