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Paying Off an Auto Loan Is Bad For Your Credit Score!?

Dave Ramsey tells people that FICO scores aren’t credit scores; they’re “I love debt” scores. Case in point: Last week, I paid off my auto loan. This week, my FICO score dropped 60 points. Sixty! There have been no other changes to my credit report.

Needless to say, I’m pretty flabbergasted…and pissed off…that my score dropped that much for doing something good…paying off debt!

I didn’t really think about the credit score consequences paying this debt because I’m not worried about my credit score; I’m worried about becoming debt-free. And although I could have predicted that my score would’ve taken a small dip for paying off a loan, I didn’t expect my credit to be so harshly punished for it. (From my understanding, there are two things at work here: Having an auto loan improves your “credit mix” because it shows you can make a big, fixed payment on time. Secondly, I wonder if closing/paying off the loan removes all of the good, on-time payments from your credit report. That seems silly…the fact the loan is now paid off doesn’t change that I paid on time, every time).

Anyway, I was quite surprised this happened. I think it’s interesting, however, that if somebody were planning to finance new car, they might think it better to pay off their old auto loan first. But that may not be the best thing to do, after all. Fortunately I have no plans to use credit anytime soon, but I do hope that my score comes back up fairly quickly.

Has this ever happened to you?

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. If you’re going to be debt-free, your score is going to continue to take dives. And if you are truly concerned about being debt-free, it won’t bother you. You shouldn’t need a debt score anymore because you will be paying cash for everything if you are following Dave’s plan.

  2. Thats sucks! sorry to hear your score took such a dive. I never knew that could happen, but I am sure your score will rebound in the next few months. and like Kaye said, don’t worry about b/c cash will be your new king.

  3. My score went down as well when I paid off our second car. It did not go down much, 6 points according to CreditKarma.com, but that was as much as it had went down when I took on another 3,000 of credit card debt to remove PMI from my mortgage.

  4. David Weliver says:

    You’re right Kaye, it shouldn’t bother me. ZERO debt is the only goal that matters at the moment. Thanks for the encouragement!

  5. I guess improving ones credit rating and being debt-free are in the opposite ends of the spectrum of being financially free.

  6. This article supports my viewpoint on Ramsey. Though his debt free strategy is pretty straight forward and relate-able to the mundane of his “financially troubled” listeners, he fails to evolve to the understandings of how to leverage financial power WHILE being debt free. The fico system does not directly follow his philosophy, therefore what may be good for his broke listener may not eventually get you the best rate on a mortgage, rather hurt your overall credit history & scoring potential in the long run.

    To me, since he is in the business to sell the products behind his brand, it would be a conflict of interest to address, and narrow his listening base rather then widening it. Personally, I have taken bits and pieces from his guidance, but left the rest behind.

  7. That doesn’t surprise me at all. I wasn’t checking my score, at the time, but I paid my car off 2 years ago. Though I KNOW it affected my credit score, I’m so glad I don’t have that piece of debt right now.

    In a CMAC course-on-CD I listened to, recently, they said that a good credit report and score must have 1 mortgage, 1 installment loan (automobile, etc.), and 2 credit cards on it. All had to still be ‘active’ in order to boost your score.

    So yes, David, it’s more a case of “how balanced is your mix of debt?” than “how well have you paid your bills?”

  8. David Weliver says:

    @Kevin, I agree about where you disagree with Ramsey. His system is easy-to-understand and black and white, which I think is what has helped it become so popular, but you still want a good credit score to get the lowest interest rate on a mortgage…even if you go with the 15-year fixed he recommends.

    @Adam thanks for confirming that about the “credit mix”. It’s what suspected; I can understand why it works that way; I just don’t understand why an open loan is better than a paid-in-full one. Oh well!

  9. David–You can still have a good score without that exact mix. I haven’t had a car payment in over 5 years and I still have a score over 700. I guess my overuse of credit cards in the past has made up for my lack of car loan.

    However, that no longer matters to me anymore. I’m all about being debt free now!

    David & Kevin–And as far as Ramsey’s view on a mortgage. He actually recommends using a mortgage company or bank that does manual underwriting of mortgages and therefore look at things other than a credit score (for example…even if your score sucks, if you have lots of money in the bank and no debts, you are obviously better off than in debt with a high score). So that’s how Dave Ramsey gets around the idea of using a credit score for a mortgage approval.

  10. This makes me wonder if it would be worth it to refinance an auto loan if I plan on purchasing a home in the nearby future. For an example: I just bought a brand new truck with a good portion of it finance through my bank for the next 5 years. I plan on buying a home within the next 6-7 years. If my assumptions are correct, cutting an auto loan monthly payment in half via refinance a few years down the road will help maintain a higher credit score and possibly help out on the interest rate on my new home… So maybe you have to spend money to save money if that makes any sense.

  11. I’m curious to know whether it was just a final payment on your auto loan, or did you pay it off with a lump sum? A 60-point drop is pretty steep, no matter the case. It’s great that you paid off the debt, but now, are you expected to rebuild a debt to increase your FICO score? I’ll never understand.

    • David Weliver says:

      @RainyDay I paid it off about six months early, so yeah, not sure that had a different effect on the score. I’ll definitely report back on how quickly the score (hopefully) comes back up.

  12. Wow, thanks for posting this, David. I had wondered about that, particularly in terms of other installment loans. Thanks for sharing your recent experience.

  13. David Weliver says:

    An update for those interested: I’ve done some further investigating into my credit scores. Sure enough, my Equifax FICO score (the one I get via myFICO ScoreWatch alerts), dropped 60 points upon paying off my auto loan.

    My TransUnion FICO score (most similar to the score you can get free through CreditKarma.com, is unchanged).

    To further confuse things, I checked my Experian “Plus” Score, which is also unchanged. (If you’re an AMEX cardmember, they’re offering a no-strings attached free Experian credit report and score right now. Log into your account for details).
    The downside is that lenders don’t use the Experian PLUS score, so I’m not sure how useful it is. (I verified, btw, that all the auto loan is reported as paid-off on all three bureau credit reports).

    So the mystery continues.

    Another moral of the story is, it really is important to keep track of all of your credit reports/scores, especially if you’re going to walk in to get a loan. As of today, I have very good to excellent credit scores with two bureaus but a score that is just barely considered “good” with Equifax. That could be a difference of $100k in interest on a 30-year mortgage.

  14. It might also be the phases of the moon, lack of inquiries, reduction in over all debt reported. Who knows.

  15. Over the past 5 months, I finished paying off a 5 year car loan from Toyota (on time) as well as a balance on my HELOC. As a result, my credit score dipped below 800 for the first time. Go figure.

  16. I just paid off my car loan, about four months early, took on a new mortgage, and my credit score dropped 10 points. It does not make ANY sense to me. I have not missed any payment in over 4 years, and I’m getting closer and closer to being debt-free, aside from my mortgage (of which I’m paying more toward the principal than required every month). I will never understand why getting rid of debt decreases your score. IDIOTIC if you ask me.

    I’ll just settle for less debt and a lower score, thank you very much……poop on FICO!

  17. Ron, Jr. says:

    Paid off a car loan on time every payment for 5 years. Score on May 2 was 746. Score on May 5 (after payoff acknowledged) was 726. Looking to secure new car loan before I pay my mortgage off on July 2′ which will probably drop my score 50 points. How stupid is the system?

  18. Great info everyone…. I just got through a divorce and I’m attacking my debt & butchered credit score, my now ex wife took care of the bills.

    I completed one of Dave Ramsey’s classes a while ago… and I know that he’s ‘anti fico’…. or whatever… but I’m… ‘pro’ lower interest rate… :-) which requires a higher FICO score… would Dave finance me for a 300k house if my credit score was below 600 ? :-)

    seriously.. sorry.. I was wanting to pay off my truck load in the next 8 months and which would make it paid off in 2 years instead of 5…

    I’m really working on paying off debt, and improving my credit score… since it’s good to have mixed debt, and I got my truck by myself while married, I was denied when we applied jointly. my truck payment history is flawless.

    I’m looking to buy a house in the next year…. but I was wanting to keep my truck payment since it’s a new and good payment history debt.

    what would you guys think that if I paid 3 to 4 times my truck payment per month over the next 8 months… then leave a ‘payment balance’ of 6 to 8 payments. That way I reduce my debt, improve my debt to income ratio, keep the payments ( a little bit ) which would help to continue my credit payment history ? I would like to really have the truck paid off in the next 8 months because I want to reallocate my truck payment into partial house payment….

    thoughts ?

    • If your looking to purchase a home, there are three major things lender ‘s look at (4 if you include time at your employer); Income, debt, and credit score. Buying a home should be done using a three year plan (or two if you can get it all in). To start, save money through a budget, form a plan to eliminate debt, and apply for as much new credit as possible. When your playing the credit game, most of you see a decreases in scores because everyone thinks it’s great to pay everything down. In theory yes, but remember, you need longevity, a good ratio, and at least 3 major lines of credit to optimize your score. Once a fixed loan is paid off, it closes and no longer counts. It will become part of your history, but that’s it. Those who don’t have other items to replace the active lines will immediately see a decrease. The new lines of credit will help those with credit card debt as well as your overall scoring.

      After year one, your credit inquiries will fall off, and your new credit lines will help your ratios as well as build longevity. Year Two begins with taking a look at your income and subtract your debt levels and see what that is (after taxes). then see if you can afford. Most home sites have calculators. Use them see what 35% of your available income is after subtracting only the min monthly payments on your credit report. Keep following this until you get a good down payment and a month before applying, don’t use credit and get all your avail balances down to zero. That’s what we did. It got our middle score above 740 which earned us top rate.

      Remember each bureau is different, but most banks and lenders will take the middle of the three. Hope this info helps.

  19. Googlegirl-On-Twitter says:

    Well.. I am finishing my last month of two car payments.. I can’t wait for my credit score to go down!

    Regards,

    Googlegirl on Twitter

  20. Credit score dropped from 750 to 685 after paying off a car loan 24 months early. Have two credit cards, mortgage, never been late in my life. Will never understand I guess.