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Background information:

I have a car loan that doesn't require payments if I'm ahead on the loan (but accrues the interest, of course, on the balance remaining). I still have a year and a half on my loan, and all my credit score reports show my only negative as being either average age of accounts and/or number of accounts.

I've got the funds to pay off the loan now, but that would close the account. I've had the thought of paying off all but one dollar (which would accrue effectively no interest in the next year and a half) to keep the account alive and paid as agreed instead of paying it all off for a longer period of time.

Question:

Is there any particularly strong reason that I should pay the account in full now or, contrarily, keep it open as long as possible? I know for credit cards the goal is to keep them open as long as possible, but not sure how loans work.

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Have you ready your question out loud? Do you intend to borrow money in the near future where a small score difference will matter? Pay off the loan. – Pete B. Feb 10 at 16:36
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@PeteBelford there is a very strong probability in the next three years I'll have either a new car loan (I drive 30-40k mi/yr, so car can't last forever) or a second mortgage (on a different property). With the general mantra of "keep accounts open as long as possible", I don't see why this question is silly. – guifa Feb 10 at 16:43
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Its your money and future so please feel free to do what you want. You are being silly because you imply wanting to make smart money decisions yet make poor ones. Why would you have a car loan if your cars depreciate faster than most normal cars? Buy something for cash, around 6K, and drive it for three years. This way you are losing like 5500 every three years, not over 15K. Why chase your tail to obtain a credit score. Pay cash for stuff. – Pete B. Feb 10 at 16:49
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I paid off a 5-year car loan in 4 years. My credit score dropped by only 4-6 points for some bureaus due to the account being closed. It's feels heavily negligible and I have lost zero sleep; in fact, I gained sleep because the sheer number of loans over my head have been reduced. – MonkeyZeus Feb 10 at 21:32
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@PeteBelford Given how much difference your credit score can make on large loans (like car loans or mortgages), I don't think it's silly at all to ask a question about how to best improve your credit score. – HopelessN00b Feb 11 at 4:00

10 Answers 10

up vote 112 down vote accepted

If I were you, I would pay off the car loan today.

You already have an excellent credit score. Practically speaking, there is no difference between a 750 score and an 850 score; you are already eligible for the best loan rates. The fact that you are continuing to use 5 credit cards and that you still have a mortgage tells me that this car loan will have a negligible impact on your score (and your life).

By the way, if you had told me that your score was low, I would still tell you to pay off the loan, but for a different reason. In that case, I would tell you to stop worrying about your score, and start getting your financial life in order by eliminating debt. Take care of your finances by reducing the amount of debt in your life, and the score will take care of itself. I realize that the financial industry stresses the importance of a high score, but they are also the ones that sell you the debt necessary to obtain the high score.

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Yes, yes, yes. And there's a certain peace of mind that comes with paying off a loan. Getting the auto title cleared and receiving your pink slip in the mail is equally rewarding. – Rocky Feb 10 at 18:56
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What a nice answer..seriously +1. – JonH Feb 11 at 15:30
    
wow, nice is right. i'll be on the lookout for more answers by ben miller in the future! – sgroves Feb 11 at 23:25
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financial industry stresses the importance of a high score, but they are also the ones that sell you the debt necessary to obtain the high score YES! – Ejaz Feb 12 at 20:14

a link to this article grabbed my Interest as I was browsing the site for something totally unrelated to finance.

Your question is not silly - I'm not a financial expert, but I've been in your situation several times with Carmax Auto Finance (CAF) in particular.

A lot of people probably thought you don't understand how financing works - but your Car Loan set up is EXACTLY how CAF Financing works, which I've used several times. Just some background info to anyone else reading this - unlike most other Simple Interest Car Financing, with CAF, they calculate per-diem based on your principal balance, and recalculate it every time you make a payment, regardless of when your actual due date was.

But here's what makes CAF financing particularly fair - when you do make a payment, your per-diem since your last payment accrued X dollars, and that's your interest portion that is subtracted first from your payment (and obviously per-diem goes down faster the more you pay in a payment), and then EVerything else, including Any extra payments you make - goes to Principal. You do not have to specify that the extra payment(S) are principal only. If your payment amount per month is $500 and you give them 11 payments of $500 - the first $500 will have a small portion go to interest accrued since the last payment - depending on the per-diem that was recalculated, and then EVERYTHING ELSE goes to principal and STILL PUSHES YOUR NEXT DUE DATE (I prefer to break up extra payments as precisely the amount due per month, so that my intention is clear - pay the extra as a payment for the next month, and the one after that, etc, and keep pushing my next due date). That last point of pushing your next due date is the key - not all car financing companies do that. A lot of them will let you pay to principal yes, but you're still due next month. With CAF, you can have your cake, and eat it too. I worked for them in College - I know their financing system in and out, and I've always financed with them for that very reason.

So, back to the question - should you keep the loan alive, albeit for a small amount. My unprofessional answer is yes! Car loans are very powerful in your credit report because they are installment accounts (same as Mortgages, and other accounts that you pay down to 0 and the loan is closed). Credit cards, are revolving accounts, and don't offer as much bang for your money - unless you are savvy in manipulating your card balances - take it up one month, take it down to 0 the next month, etc. I play those games a lot - but I always find mortgage and auto loans make the best impact.

I do exactly what you do myself - I pay off the car down to about $500 (I actually make several small payments each equal to the agreed upon Monthly payment because their system automatically treats that as a payment for the next month due, and the one after that, etc - on top of paying it all to principal as I mentioned).

DO NOT leave a dollar, as another reader mentioned - they have a "good will" threshold, I can't remember how much - probably $50, for which they will consider the account paid off, and close it out. So, if your concern is throwing away free money but you still want the account alive, your "sweet spot" where you can be sure the loan is not closed, is probably around $100.

BUT....something else important to consider if you decide to go with that strategy of keeping the account alive (which I recommend). In my case, CAF will adjust down your next payment due, if it's less than the principal left. SO, let's say your regular payment is $400 and you only leave a $100, your next payment due is $100 (and it will go up a few cents each month because of the small per-diem), and that is exactly what CAF will report to the credit bureaus as your monthly obligation - which sucks because now your awesome car payment history looks like you've only been paying $100 every month - so, leave something close to one month's payment (yes, the interest accrued will be higher - but I'm not a penny-pincher when the reward is worth it - if you left $400 for 1.5 years at 10% APR - that equates to about $50 interest for that entire time - well worth it in my books.

Sorry for rambling a lot, I suck myself into these debates all the time :)

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Thank you for detailing how the mechanics of the payment and interest work. I have to disagree with the second half of the answer, though. I wouldn't recommend paying $50 in unnecessary interest in an attempt to boost the OP's already high score. Welcome to Money.SE, though. I hope to see more posts from you. – Ben Miller Feb 13 at 13:03

There's two scenarios: the loan accrues interest on the remaining balance, or the total interest was computed ahead of time and your payments were averaged over x years so your payments are always the same. The second scenarios is better for the bank, so guess what you probably have...

In the first scenario, I would pay it off to avoid paying interest. (Unless there is a compelling reason to keep the cash available for something else, and you don't mind paying interest)

In the second case, you're going to pay "interest over x years" as computed when you bought the car no matter how quickly you pay it off, so take your time. (If you pay it earlier, it's like paying interest that would not have actually accrued, since you're paying it off faster than necessary)

If you pay it off, I'm not sure if it would "close" the account, your credit history might show the account as being paid, which is a good thing.

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This misses the point of the question, which is whether to leave a credit account open with just one dollar, regarding the credit score – the available cash as well as the interest would be almost the same in both cases. – Paŭlo Ebermann Feb 13 at 17:59
    
NO, it is very relevant. If your payments are predetermined, on a longer term loan you will be in arrears once your "scheduled payments" fall behind, regardless of the ledger balance. This is the opposite of a "balloon". Any loan with a pre-determined credit charge should be paid off early. – mckenzm Feb 14 at 22:26

Not sure if it is the same in the States as it is here in the UK (or possibly even depends on the lender) but if you have any amount outstanding on the loan then you wouldn't own the vehicle, the loan company would.

This often offers extra protection if something goes wrong with the vehicle - a loan company talking to the manufacturer to get it resolved carries more weight than an individual. The laon company will have an army of lawyers (should it get that far) and a lot more resources to deal with anything, they may also throw in a courtesy car etc.

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You have a good point but then go off a bit. You don't own the car until you have the title, which you don't possess until the lien is cleared. It's silly to leave technical ownership in someone else's hands. As long as the bank holds the title, you're going to be forced to do things like have mandatory comprehensive insurance coverage on your car (which may or may not be worth it depending on its value). – Ivan Feb 11 at 18:47

In some states there are significantly higher automobile insurance costs and higher coverage requirements for vehicles that have a lien on them. I suspect this is not your scenario, or you probably would not be considering holding the loan open. But it is something to consider.

If you live in a state where insurance coverage and costs depend on a clear title, I would certainly recommend closing the loan as soon as possible.

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As an FYI, working for a lending company, I can tell you many have a dollar amount limit that they'll just write off at the end of the month/quarter/etc just to get the loan off the books. It's a little goofy, but I actually bothered to plan ahead and save $9.99 on my student loans since the lender would close out all accounts with a < $10 balance.

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what you aim to do is a great idea and it will work in your favor for a number of reasons.

First, paying down your loan early will save you lots in interest, no brainer. Second, keeping the account open will improve your credit score by 1) increases the number of installment trade lines you have open, 2)adds to your positive payment history and 3) varies your credit mix.

If your paid your car off you will see a DROP in your credit score because now you have one less trade line.

To address other issues as far as credit scoring, it does not matter(much) for your score if you have a $1000 car loan or a $100,000 car loan. what matters is whether or not you pay on time, and what your balance is compared to the original loan amount. So the quicker you pay DOWN the loans or mortgages the better. Pay them down, not off!

As far how the extra payments will report, one of two things will happen. Either they will report every month paid as agreed (most likely), or they wont report anything for a few years until your next payment is due(unlikely, this wont hurt you but wont help you either).

Someone posted they would lower the amount you paid every month on your report and thus lower your score. This is not true. even if they reported you paid $1/ month the scoring calculations do not care. All they care is whether or not you're on time, and in your case you would be months AHEAD of time(even though your report cant reflect this fact either) HOWEVER, if you are applying for a mortgage the lower monthly payment WOULD affect you in the sense that now you qualify for a BIGGER loan because now your debt to income ratio has improved.

People will argue to just pay it off and be debt free, however being debt free does NOT help your credit. And being that you own a home and a car you see the benefits of good credit. You can have a million dollars in the bank but you will be denied a loan if you have NO or bad credit. Nothing wrong with living on cash, I've done it for years, but good luck trying to rent a car, or getting the best insurance rates, and ANYTHING in life with poor credit. Yeah it sucks but you have to play the game.

I would not pay down do $1 though because like someone else said they may just close the account. Pay it down to 10 or 20 percent and you will see the most impact on your credit and invest the rest of your cash elsewhere.

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Nobody outside of the credit scoring agencies know exactly what goes into the scoring formula. That said, I don't think there is sufficient evidence that keeping a fixed loan (car or mortgage) open is necessary to keep its effect on your score. It doesn't improve your utilization ratio like an open revolving credit line would. And depending on the exact details of how your specific lender reports the loan, it might appear detrimental to your debt-to-income ratio. I would simply pay it off.

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Among the other fine answers, you might also consider that owning a vehicle outright will free you from the requirement to carry insurance on the vehicle (you must still carry insurance on yourself in most states).

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I'm going to assume you mean "comprehensive coverage." – Aaron D. Marasco Feb 12 at 23:53

I used to work for Ally Auto (formerly known as GMAC) and I'd advise not to pay off the account unless you need to free up some debt in your credit report since until the account is paid off it will show that you owe your financial institution the original loan amount. The reason why I am saying not to pay-off the account is because good/bad payments are sent to the credit bureau 30 days after the due date of the payment, and if you want to increase your credit score then its best to pay it on a monthly basis, the negative side to this is you will pay more interest by doing this.

If ever you decide to leave $1.00 in loan, I am pretty much sure that the financial institution will absorb the remaining balance and consider the account paid off.

What exactly is your goal here? Do you plan to increase your credit score? Do you need to free up some debt?

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