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Will loan payoff help or hurt credit scores?

Aug 26, 2013 | | Comments Comments Off

Dear Liz: Two years ago, my husband was denied a revolving $12,000 line of credit. The credit reporting agency indicated that denial was based on “little revolving usage, insufficient or no bank lines, and insufficient open accounts with zero balances.” Nine months ago, however, he was approved for a car loan and received a FICO Auto V2 Score of 808 from the same credit reporting agency. Another credit reporting agency gave him a FICO Auto 04 Score 836. We had wanted to pay cash for this car but thought it would be wise for my husband to improve his credit, so he got an interest-free loan. My husband was recently approved for and obtained a credit card with a $20,000 revolving credit limit. He previously had a card with a $2,000 limit. He will pay off the balances each month. Our question: How long should he wait to pay off the car loan so that the payoff helps his credit and doesn’t hurt it? We don’t like having outstanding debt and have no other loan obligations.

Answer: Occasionally there’s a conflict between doing what’s best for your finances and doing what’s best for your credit scores.

Paying off an installment loan early, for example, normally is good for your wallet since you’re saving money on interest. But this payoff may come with a cost. While the closed account can remain on your credit report for years, contributing positively to your scores, you’ll get somewhat more of a positive impact if you don’t rush to pay it off. The open account will do more good for your scores than a closed account.

In your case, however, there is no conflict. This is an interest-free loan, so you’re paying absolutely nothing for the option of keeping the account open as long as possible. If your primary concern is supporting your husband’s excellent credit scores, consider getting over your aversion to debt and enjoy the free use of the lender’s money.

(OK, it may not be totally free. Buyers who get zero-interest loans often pay more for their cars than those who get market interest rates, according to Edmunds.com. But we’ll assume you thrifty folks bargained hard and really did get free money.)

If your husband can’t tolerate having any debt, he can keep good scores simply by using those credit cards lightly but regularly. The less he uses of his credit limit on the cards each month, the better: 30% or less is good, 20% or less is better, 10% or less is best. Paying the balances in full will ensure he doesn’t have to pay a dime in interest to keep his scores in good standing.

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Categories : Credit Scoring, Q&A