Why Doesn’t Paying Off An Installment Loan Improve my Credit Scores?
“I liquidated my IRA and paid off my truck but my credit score didn’t go up.” This is another scoring myth that may not make sense, but it is based upon statistical data – the myth is regarding the impact of paying off an installment account early. An installment account is for a fixed amount and/ or a specific time frame and is secured. Examples are mortgage loans and vehicle loans, which are secured by your home or vehicle. For each loan, there is a fixed amount due each month. An example is a mortgage payment of $800 a month for a set time frame of 20 years. But why don’t your scores go up if you pay off those loans early?
The reason paying off an installment loan early doesn’t shoot your scores through the roof is because the debt wasn’t having much of an impact on your scores in the first place. Installment debts tend to be more stable and less predictive of elevated credit risk. Recent history notwithstanding, most people don’t want to lose their homes or cars due to non-payment. So, we’re more willing to pay them over our unsecured debts, like credit cards.
You can be in several hundred thousand dollars of installment loan debt and still have fantastic credit scores. When you pay off the debt, you’ll still have fantastic credit scores. But liquidated an IRA to pay off a truck loan early…ouch! That was a bad move. You created a taxable event and your score didn’t go up.
If you want to pay off an installment loan early, go for it. Debt is debt and nobody wants it. I’m about to sell my home and it will do away with almost $550,000 worth of mortgage debt. My scores won’t go up much, if at all.
Now, if I had a large amount of credit card debt…that’s a different story. Because credit card debt is largely unsecured the risk to the lender is much greater. Because it’s a riskier type of loan it has a much more significant impact to your credit scores. I’m still not sure liquidating an IRA to pay off credit card debt is a good idea but you will certainly get more bang for your buck than paying off an installment loan.