Looking to improve your credit rating? Doubling up on your monthly payments—whether they’re for your auto loan or your mortgage—isn’t guaranteed to help you get any more points on your credit score.
There are some compelling financial reasons for doubling up on payments. For one thing, you can save thousands of dollars in interest. Suppose you have a 30-year mortgage of $200,000 and owe about $1,000 a month for your payment. If you can swing another $1,000 a month and put it towards the principle you owe, you’ll not only save more than $114,000 in interest, but also shorten your mortgage repayment period by 19 ½ years. Even if you can put only $500 a month toward extra payments, you’ll keep $88,000 in your own pocket instead of paying it out to the mortgage company. You’ll also reduce your mortgage repayment period by almost 15 years.
Car loans work the same way. If you have a five-year, $20,000 car loan at seven percent interest, you’re paying almost $400 a month. Increase that payment by $100 and you’ll own your car outright a year earlier and save almost $900 in the process.
So while you’re getting all these savings are you also improving your credit record? Unfortunately, the answer is probably not.
Credit bureaus aren’t impressed when you’ve paid off a loan early; their concern is whether you’ve made at least the minimum payments for the loan on time without skipping any payments. So keeping your accounts up-to-date will help keep a good credit score, but early payoffs by themselves don’t win you any credit score points.
If you pay off your loan early your credit score might even drop a few points over time, since completing will mean closing out your account. This can affect you in a few ways. First, credit bureaus give more weight to active accounts when they assign credit scores. If you double up on your payments and pay off your loan two years early, the lender will stop reporting on the loan and the loan will disappear from your credit history that much sooner. They also like to see credit that’s been established for awhile, so having a loan account open for five years or more can be a good thing.
In addition, credit card bureaus want you to have a mix of credit types, including credit cards and installment loans; ten percent of your credit score is based on your credit mix. So if your car loan is the only installment loan you have, you may lose points because you no longer have the same variety of credit.
If you’re trying to give your credit score a quick boost, you might consider doubling up on your credit card payments or at least taking some of the money that you were going to use to pay off a loan early and put it towards reducing your credit card debt. Credit bureaus do take into account your credit utilization ratio, that is, the amount of debt you owe in relation to the amount of credit that you have. The amount of credit you are using accounts for about 30 percent of your credit rating.
Suppose your credit limit on all of your credit cards combined comes to $10,000. You owe $2,000 on one card, $500 on another and $1,500 on yet another, for a total indebtedness of $4,000. Your utilization rate is 40 percent ($4,000 divided by $10,000.) That’s high—credit bureaus like to see utilization rates of no more than 30 percent, and the lower the utilization rate the better.
So if raising your credit score is a high priority for you, don’t double up on a car payment. Instead apply that extra $200 or so to your credit card bills. In just five months (assuming you don’t get more deeply into debt) you could cut your outstanding balance to $3,000, bringing your utilization rate down to 30 percent. That’s likely to have a much larger impact on your score than doubling up on loan payments.