Many financial advisors will tell you that it’s a bad decision to buy a new car and, to be honest, they’re right. The fastest depreciation in a vehicle’s value occurs during the first two years, and you’ll definitely get more bang for your buck if you buy a car that’s a few years old. However, there is more to any life decision than just considering what is the best decision financially.

For me, I prefer the peace of mind that a new car provides. I have a factory warranty on the vehicle and don’t have to worry about whether a previous owner took good care of it or drove it aggressively. Plus, I like to keep the same vehicle for a long time, so I’m not that concerned with how the retail or trade-in value changes over time.

I bought a new Ford Expedition a few years ago. For a new car, I did it the financial advisor way because my car was a leftover from the previous model year and I got a substantial discount because the dealer wanted to get rid of it. Even so, it was too expensive to pay with cash, and since it was the era of very low-interest financing, I got a car loan with an interest rate below 4%.

Well, earlier in 2024 I finished paying off the loan (over a year early). And as soon as the “paid in full” designation appeared on my credit report, my FICO® score dropped about 10 points.

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Why paying off a loan can lower your credit score

Now, it may seem counterintuitive that a paid off car loan (clearly an example of responsible credit behavior) would have a negative impact on your score. But if we take a closer look at how the FICO scoring formula works, it makes a lot of sense.

A key point to know before continuing is that a repaid loan is officially considered a farm account. And for this reason, it can have negative implications on your credit score. You may have heard that closing an old credit card can lower your credit score. The same applies here.

The reason is mainly due to the “amounts owed” category of the FICO formula, which represents 30% of your credit score.

Instead of focusing on the actual amounts you owe to creditors, it takes into account how much you owe on your credit cards versus your total credit limit and how much you owe on installment loans versus to the initial balance.

In other words, a 95% paid-off auto loan can be a pretty positive factor in your FICO® Score, especially if it has an impeccable payment history. However, once you have made the last payment, it appears as a closed account and no longer has a positive influence on your score.

In addition to the amounts owed category, there are two other ways that paying off my car loan may have impacted my credit score.

Length of my credit history (15% of my score): This category takes into account time-related factors, such as the age of your credit accounts. Since my auto loan has been established for several years and is the older of the two non-mortgage installment loans listed on my credit report, this could have affected this area of ​​the scoring formula.

Mix of credits (10% of my score): In a nutshell, lenders want to see that you can be responsible with a variety of different forms of credit, which is why the FICO formula rewards a diverse mix of accounts. By eliminating my only car loan, it could have made my credit mix less favorable.

The fall didn’t bother me

Even though my FICO® score dropped about 10 points in response to paying off my car loan, it didn’t bother me. On the one hand, I’ve been a financial planner for a while now and am very familiar with how actions like this are factored into the credit scoring formula. And my score was far enough into the realm of excellent credit to stay there, even after a 10-point drop.

More importantly, a slight drop in my credit score is nothing compared to eliminating that monthly payment from my budget, having my car title physically in my possession, and paying off the loan early , I save about $1,000 in interest.