Can quickly repaying a car loan help rebuild credit?

Question for the expert

Dear Credit Score Report,
I'm trying to rebuild my credit. I took out a joint car loan with my fiancee. The problem is we have a high interest rate. My fiancee would like to pay the loan off ASAP to avoid paying so much in interest. Will this help my credit rating to pay it off within six months or should I continue to make the monthly payments to help my credit score? We are trying to get my score the best it can be so we can eventually buy a house and weren't sure what would help my score the most. -- Vicki

Answer for the expert

Hey Vicki,
Since a record of on-time payments are the key to building good credit, focus on the consistency of your repayments before turning your attention to speed.

When rebuilding your credit, experts say the most important step is never paying late. That includes auto loans. "It really makes little difference if the note is paid off early. The key issue is that it was paid in full with no delinquencies," says Rod Griffin, director of public education with credit bureau Experian. An account that's been open for six months and appears on your credit report will be enough to generate a FICO credit score. Therefore, based on your time line, if you've made every car payment up to this point on or before the due date, you should be able to safely pay off the remaining debt. "The best of both worlds would be to show a track record of good payments, followed by paying off the loan early," says Gail Cunningham, vice president of public relations for the National Foundation for Credit Counseling. If you've slipped up in the past, however, hang onto that loan for a little longer to show that you can manage it more effectively.  

Once that joint account's history of on-time payments appears on your credit report, you can think about speeding up those repayments. As you've already realized, paying off that car loan early will save you money on interest payments. "If they have other debts, they can use the funds previously committed to the car loan to reduce those debts," Griffin says. Doing so will lower your utilization ratios -- or debt levels relative to credit limits -- and your overall indebtedness, which typically strengthens credit scores, Griffin adds. Do make sure you won't be penalized for getting ahead of the game, however. "They need to be sure and check the terms of the loan to confirm that there are no prepayment penalties," Cunningham says. 

There are plenty of other factors that drive your credit score as well. For example, to get an excellent credit score, you'll need to prove you can handle other types of accounts, too. That's because credit scoring models typically reward borrowers who successfully handle a variety of debt, such as auto and home loans (nonrevolving or closed-end) and credit cards (revolving). "A vehicle loan is an example of a closed-end account, in that it is for a set amount of money for a certain term," the NFCC's Cunningham says. "Do they perhaps have another vehicle payment or loan that would satisfy this category, thus paying it off wouldn't hurt? Also, do they have other open and active lines of credit?" she asks.  

If not, consider selectively opening some different account types well before you apply for a home loan. (Since taking on new loans can impact your credit score, however, be careful about opening numerous credit cards or other taking on additional debt obligations, particularly when you're about to apply for that mortgage. And of course, if you can't afford to take on more debt, you shouldn't do it -- regardless of any potential help to your credit score.) "Any lender, particularly a mortgage lender, wants to see a thick and positive credit file," Cunningham says, noting that a "thick" file usually means three or more open and active accounts. In your case, that number currently includes your existing auto loan. Look over your credit report to make sure all your accounts are listed and get any errors get corrected. "If closing this account would put them below that threshold, it might not play in their favor," Cunningham says. FICO agrees. "Generally speaking, having one or more active installment loan accounts is better for one's score than having only closed loans, and having only closed installment loans on one's credit report is better for the FICO score than having no installment loan record at all," says Ethan Dornhelm, principal scientist at FICO.

Of course, paying off and closing that account early isn't the only way to save money. Refinancing, or establishing a new loan, could bring you better terms if your credit score has improved since you initially purchased that car. Start by educating yourself about your current loan. You can compare your existing auto rate to the national averages to see how your current loan rate compares. If your credit has improved since you initially took out the car loan, a refi should offer you a lower interest rate. (Bankrate lets you compare auto refinance rates.) As discussed earlier, the savings on interest payments can be put toward paying off other debts or toward creating a savings account for that eventual home purchase.

Such responsible behavior will help you in the long run. "It is very important to demonstrate good financial habits beyond credit when applying for a mortgage loan today," Experian's Griffin says. "Lenders often require a substantial down payment and may ask that you have money in savings to ensure you can continue to make the mortgage payments in the event of unforeseen economic challenges."

Good luck!

-- Jeremy 

See related: Credit card authorized users, joint account holders differ, 'Hard' inquiries have limited credit score impact, Free credit reports: How to get the actual free one, How to dispute credit report errors Decade-old credit mistakes shouldn't appear on your report, How to cancel a credit card

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Updated: 01-23-2019