Does Closing a Loan Account Hurt Your Credit?

In today’s fast-paced financial world, managing credit is more critical than ever. With rising inflation, fluctuating interest rates, and economic uncertainty, consumers are increasingly cautious about their credit health. One common question that arises is: Does closing a loan account hurt your credit? The answer isn’t straightforward—it depends on multiple factors, including your credit history, the type of loan, and how you manage other credit accounts.

How Credit Scores Work

Before diving into the impact of closing a loan account, it’s essential to understand how credit scores are calculated. The FICO and VantageScore models, the two most widely used scoring systems, consider several factors:

1. Payment History (35%)

Your track record of making on-time payments is the most significant factor. Late or missed payments can severely damage your score.

2. Credit Utilization (30%)

This measures how much of your available credit you’re using. A lower utilization rate (ideally under 30%) is better for your score.

3. Length of Credit History (15%)

The longer your accounts have been open, the better. Closing an old account can shorten your average credit age.

4. Credit Mix (10%)

Having a diverse mix of credit (e.g., credit cards, mortgages, auto loans) can positively impact your score.

5. New Credit Inquiries (10%)

Applying for multiple new credit lines in a short period can lower your score temporarily.

The Impact of Closing a Loan Account

Now, let’s break down how closing a loan—whether it’s a mortgage, auto loan, or personal loan—affects your credit.

1. Positive vs. Negative Loan Accounts

If the loan you’re closing had a perfect payment history, closing it could remove that positive record from your credit report. Conversely, if the loan had late payments, closing it won’t erase those negative marks—they’ll stay on your report for up to seven years.

2. Credit Utilization (For Revolving Accounts)

Closing a loan doesn’t directly affect credit utilization because loans are installment accounts (fixed payments over time). However, if you also close revolving accounts (like credit cards), your overall available credit decreases, which could increase your utilization ratio and hurt your score.

3. Average Age of Accounts

If the loan was one of your oldest accounts, closing it could reduce your average credit age, potentially lowering your score.

4. Credit Mix

If the loan was your only installment account, closing it might reduce your credit mix diversity, slightly lowering your score.

Real-World Scenarios

Paying Off a Mortgage Early

Many homeowners wonder if paying off their mortgage early will hurt their credit. While it’s a significant financial achievement, closing a mortgage account could:
- Remove a long-standing positive payment history.
- Reduce your credit mix if you don’t have other installment loans.
However, the impact is usually minor unless you have a thin credit file.

Closing an Auto Loan After Payoff

Auto loans are typically shorter-term. Once paid off, the account will eventually fall off your report. The immediate effect is minimal unless it was your only installment loan.

Personal Loans and Credit Builder Loans

These loans are often used to improve credit. Closing them after repayment may slightly lower your score if they were helping your credit mix or average age.

Strategies to Minimize Negative Effects

If you’re considering closing a loan account, here are ways to protect your credit:

1. Keep Other Accounts Open

Maintain at least one or two credit cards or other active accounts to preserve your credit history and utilization ratio.

2. Avoid Closing Old Accounts

If the loan is one of your oldest accounts, consider keeping it open (if possible) to maintain a long credit history.

3. Monitor Your Credit Report

Check your credit report regularly to ensure closed accounts are reported correctly. Dispute any inaccuracies with the credit bureaus.

4. Diversify Your Credit

If you close a loan, consider adding another type of credit (like a secured card or small personal loan) to maintain a healthy mix.

The Bigger Picture: Credit Health in 2024

With global economic instability, lenders are tightening credit standards. A strong credit score is crucial for securing loans, renting apartments, and even landing jobs. While closing a loan account may have a minor impact, responsible credit habits—like paying bills on time and keeping utilization low—will always matter more.

Ultimately, the decision to close a loan account should be based on your financial goals, not just your credit score. If paying off debt improves your financial freedom, the temporary dip in your score is often worth it. Just be strategic about how you manage your remaining credit to stay in good standing.