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Paying off a car loan can help your credit profile by reducing your debt-to-income ratio. But closing out a loan can also have several negative effects on your credit history. And paying off a loan early isn’t the best decision when there are better ways you can use that money — or save it for an emergency.

We’ll discuss how much paying off a car loan helps your credit and when paying it off early really does pay off.

How Credit Scores Are Calculated

The fact that you got a car loan means you know a little something about your credit score. But it’s always helpful to learn more about how those scores are calculated. According to FICO®, your credit rating is made up of five parts:

•   Payment history (timely payments): 35%

•   Amounts owed (credit utilization): 30%

•   Length of credit history: 15%

•   New credit requests: 10%

•   Credit mix (installment versus revolving): 10%

Whether you’re applying for a personal loan or a car loan, the same factors are used to determine your creditworthiness.

Recommended: What Credit Score Is Needed to Buy a Car?

Does Paying Off a Credit Card Help Your Credit?

For the sake of comparison, let’s say you buy a car with a credit card. (In real life, this is usually a bad idea because credit card interest rates are considerably higher than for auto loans.) How would paying off the credit card balance affect your credit score?

No matter what you’ve heard, maintaining a credit card balance doesn’t help your score. That’s because the amount you owe, also called credit utilization, accounts for 30% of your score. To calculate your credit utilization, add up the credit limits on your cards. Then divide that figure by your outstanding balance(s).

Let’s say your credit limit is $20,000. If you buy a used car for $10,000, you’re utilizing 50% of your available credit. So paying down your balance — or paying off the whole $20K — will improve your credit utilization factor.

But there’s a key difference between paying off a credit card and paying off a car loan. After you pay off the credit card balance, the account remains open (unless you take action to close it). This is called revolving credit: You can repeatedly use the funds up to your credit limit, as long as you continue to make payments.

How Paying Off Your Car Loan Early May Affect Your Credit Score

A car loan is considered an installment loan, one with a starting balance that’s paid down each time you make a monthly payment. According to credit reporting agency Experian, paying off an installment loan can briefly cause your score to dip.

That’s because the loan is no longer “active,” so your timely payment history is no longer contributing to your overall credit score. Paying off an installment loan can also affect a person’s credit mix and the average age of their open accounts.

How To Decide Whether to Pay Off Your Car Loan Early

There’s no one answer that fits every borrower. See which pros and cons below apply to your situation.

When It’s a Good Idea to Pay Off Your Car Loan Early

If any of these statements resonate with you, paying off your car loan early is likely the right decision.

•   You have trouble juggling your monthly bills and would be glad to have one fewer to deal with.

•   You hate the idea of continuing to pay interest on the loan.

•   The money you free up can be used to pay down another debt, add to your savings, or spend on pursuits you’re passionate about.

•   You’re considering taking out another loan, and paying off this one could help you qualify.

But wait! Check out the drawbacks to paying off a loan below before you decide.

When It’s Better to Keep the Loan

Even if you’re eager to pay down some debt, sometimes you’re better off financially keeping a loan. See if any of these disadvantages affect your cost-benefit analysis.

•   Instead of paying off the loan, investing the lump sum might net you more profits than you’ll save in loan interest.

•   If you’re using savings to pay off the loan, you may find yourself short in an emergency.

•   Some loans come with prepayment penalties. Make sure you won’t be charged for paying off your loan ahead of schedule.

•   As noted above, paying off an installment loan can have a negative impact on your credit mix, payment history, and length of credit history.

Recommended: Does Net Worth Include Home Equity?

About to Make Your Last Scheduled Loan Payment?

Now is the perfect time to test how much paying off the loan will impact your credit score. You may be able to find your credit score for free through various channels, such as banks, credit card companies, and credit counselors. Check your score before you make your final payment and again a few months later.

Or you can sign up for a service that monitors your credit score for you. What qualifies as credit score monitoring varies from service to service. Look for one that will alert you whenever your score changes.

You’ll also want to decide how you’re going to use those funds going forward. You may decide to pay off other debts (especially credit cards), build your savings, or invest the funds. A money tracker app can give you a helpful overview of your finances.

Paying off a car loan can sometimes lower your auto insurance premium. Check with your insurance carrier, and shop around to make sure you’re getting the best deal.

The Takeaway

The reality is that paying off a car loan may cause your credit score to dip. But it can still be the right decision if you have plenty of savings to cover the balance due. After all, you’ll save money on interest, lower your debt-to-income ratio, and have one fewer monthly bill to juggle. Whether you should pay off a car loan early depends on your financial circumstances and if you have other, higher-interest debt that should be paid off first.

Take control of your finances with SoFi. With our financial insights and credit score monitoring tools, you can view all of your accounts in one convenient dashboard. From there, you can see your various balances, spending breakdowns, and credit score. Plus you can easily set up budgets and discover valuable financial insights — all at no cost.

FAQ

How much will my credit score go up if I pay off my car?

Your credit score may actually dip after paying off a car, but it depends on your specific financial situation. That’s because paying off an installment loan can have a negative impact on your credit mix, payment history, and length of credit history.

Will paying off a car loan early improve credit?

Each situation is unique. Paying off a loan will improve your debt-to-income ratio, which lenders look at to determine your creditworthiness. However, it can also have a negative impact on your credit mix, payment history, and length of credit history.

Why did my credit score drop when I paid off my car early?

Credit score algorithms are complex, and every borrower’s situation is different. If your car loan was your only installment loan, closing it reduces your credit mix, which accounts for 10% of your score. Paying off a loan can also reduce the overall length of your open credit accounts, another factor used to calculate your score.

Photo credit: iStock/Pofuduk Images

SoFi Relay offers users the ability to connect both SoFi accounts and external accounts using Plaid, Inc.’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. Based on your consent SoFi will also automatically provide some financial data received from the credit bureau for your visibility, without the need of you connecting additional accounts. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score is a VantageScore® based on TransUnion® (the “Processing Agent”) data.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SORL-Q324-037

Whether you’re thinking about paying off a debt or mulling over how to increase your credit score — or both — it’s reasonable to ask if paying off debt helps your credit rating. The answer, though, is more complex than a simple yes or no.

Let’s unpack how paying off a debt can either raise or reduce your credit score, depending on the circumstance; how credit scores are calculated; and how managing your credit utilization can give you some control over your credit score.

How Paying Off a Debt Is Connected to Your Credit Score

What affects your credit score is on a lot of people’s mind. Your credit score is determined by five factors, some of which are weighted more than others. Paying off a debt can affect each of these factors in different ways, causing your score to rise or dip. Sometimes changes in two factors can even cancel each other out, leaving your score unchanged. This is why it’s hard to predict how paying off a debt will affect your credit.

A good first step is to find out your credit score. You may be able to get it for free through your bank, credit card issuer, or lender; through Experian; or by signing up for a free money tracker app.

Credit Score Calculation Factors

According to FICO®, a credit rating company, these are the five factors commonly used to calculate your FICO Score:

•   Payment history (timely payments): 35%

•   Amounts owed (credit utilization): 30%

•   Length of credit history: 15%

•   New credit requests: 10%

•   Credit mix (installment versus revolving): 10%

Once FICO’s algorithm calculates your score, a credit score rating scale assigns it a category ranging from Poor to Exceptional. A higher number indicates to lenders that a person is a lower risk for default:

•   Exceptional: 800 to 850

•   Very Good: 740 to 799

•   Good: 670 to 739

•   Fair: 580 to 669

•   Poor: 300 to 579

As you can see, a Fair credit score falls between 580 and 669. A Poor or bad credit score falls between 300 and 579. The minimum credit score required to qualify for a loan is around 610 to 640, depending on the lender — meaning not everyone with a Fair score would qualify.

Recommended: Do Personal Loans Build Credit?

Why a Credit Score Can Go Down After Paying Off a Debt

Paying off debt feels good and improves your financial situation. But it could also cause your credit score to drop. This negative impact can be due to changes in one or more factors, including:

•   credit utilization

•   credit mix

•   overall credit age

When you pay off a credit card and then close the account, you reduce your available credit and increase your credit utilization. Similarly, if you pay off your only car loan and close that account, you have one fewer type of account in your credit mix. Finally, paying off and closing an older account may reduce the average age of your overall credit history. (We’ll explore these scenarios in more detail below.)

While none of these things is “bad” in financial terms, it could temporarily count against you in the world of credit scores.

What Is Credit Utilization?

Now for a little more background on credit utilization. Credit utilization is a factor with revolving forms of credit, such as credit cards and lines of credit, where you can reuse the account up to your limit.

Your credit utilization rate, or ratio, is determined by dividing the sum of your credit limits by the sum of your current balances. So if someone has a $5,000 limit and is using $2,500, that’s a 50% credit utilization rate. Your rate should be kept below 30% to avoid a negative affect on your credit score.

What Is a Credit Mix?

Lenders like to see that an applicant can successfully handle different kinds of credit. This includes installment loans like mortgages, car loans, and personal loans, as well as revolving credit such as credit cards and lines of credit. If a person can manage both types of credit well, a lender will likely consider them less of a risk.

Recommended: Should I Sell My House Now or Wait?

How Credit Age Factors In

The length of your credit history demonstrates your experience in using credit. To lenders, the longer the better. When payments to an older account are on time, this combo reassures lenders that you will likely continue to make timely payments going forward.

New credit accounts can also lower your credit age. More important, opening or even applying for many new accounts in a short period of time may be a red flag to lenders that you could be in financial trouble. The application process also involves a hard credit inquiry, which can lower your credit score.

Sample Scenarios

Here are two examples of someone paying off a credit card. In one case, the credit score goes up. In another, it goes down.

Credit Utilization Goes Down / Credit Score Goes Up

Let’s say that someone has a credit utilization rate of 40%, which is negatively impacting their credit score. (Remember, below 30% is best.) When they make enough payments to bring their utilization rate down to 25%, this can boost their credit score.

Credit Mix and Age Go Down / Credit Score Goes Down

Now, let’s imagine that someone pays off the balance of their first and only credit card. This should help their utilization score! But wait: Then they close the account, and their average credit age drops. And since this is their only form of revolving credit, their credit mix has lost out, too.

Counterintuitively, paying off the card may make their credit score go down — at least in the short term.

Recommended: What Credit Score is Needed to Buy a Car?

Paying Off a Loan Early vs Paying It on Schedule

People often wonder if it’s better to pay off a loan early, if you can. In the case of a personal loan, early payoff can lower the average age of someone’s credit history, possibly lowering their credit score.

But in reality, the impact will depend upon their overall credit situation. Paying the loan off according to the schedule will keep it open longer, which can help with their credit age. On the other hand, they’ll pay more in interest because the loan is still open.

If you’re in this situation, weigh the pros and cons before making the decision that’s best for you.

How Long Can It Take To See Your Credit Score Change?

According to the credit report agency TransUnion, credit reports are updated when lenders send them new information. In general, this happens every 30-45 days, though some lenders update more frequently.

If you’re concerned about your numbers, consider signing up for a credit score monitoring service. What qualifies as credit monitoring varies from company to company. Look for a one that sends alerts whenever your score changes for better or worse.

Recommended: What Is a Tri-Merge Credit Report?

The Takeaway

How paying off a debt affects someone’s credit score depends on the person’s overall credit profile. Paying off a credit card typically helps your credit score because the account remains open, lowering your credit utilization. Paying off a loan can hurt your score because the loan is then closed, potentially reducing your credit mix and age. Generally, though, borrowers shouldn’t let credit score concerns prevent them from taking actions that are in their financial interest.

Take control of your finances with SoFi. With our financial insights and credit score monitoring tools, you can view all of your accounts in one convenient dashboard. From there, you can see your various balances, spending breakdowns, and credit score. Plus you can easily set up budgets and discover valuable financial insights — all at no cost.

FAQ

How fast does your credit score increase after paying off a debt?

In fact, your credit score may dip for a short period after a debt is paid off. Lenders report new information to credit reporting agencies every 30-45 days, though some lenders update more frequently. Generally, you shouldn’t let concerns about your credit score prevent you from taking action that is in your best financial interest.

Is it best to pay off all debt before buying a house?

According to credit report agency Experian, it generally makes sense to pay off credit card debt before buying a home. Just know that in some circumstances, paying off a debt may temporarily reduce your credit score, which can affect the loan terms you qualify for. If you do pay off a credit card, consider keeping the account open until after you qualify for a loan.

How do you get an 800 credit score?

Pay bills on time, maintain a credit utilization rate under 30%, and effectively manage your credit history length, new credit requests, and credit mix. Although this won’t guarantee a score of 800, it can help you maximize yours.

Photo credit: iStock/Patcharapong Sriwichai

SoFi Relay offers users the ability to connect both SoFi accounts and external accounts using Plaid, Inc.’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. Based on your consent SoFi will also automatically provide some financial data received from the credit bureau for your visibility, without the need of you connecting additional accounts. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score is a VantageScore® based on TransUnion® (the “Processing Agent”) data.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SORL-Q324-036

Just because you’ve closed an account, that doesn’t mean the information will automatically disappear from your credit report. That account can continue to impact your credit score for years — in good ways and not-so-good ways.

There are a few different things you can try if you want the account removed from your credit reports, but it may take some time. And since a closed account can sometimes have a beneficial effect on your credit score, you might decide it’s best to simply leave it alone.

Read on to learn more about how an account can continue to impact your credit even after it’s closed and how to get a closed account off your credit report.

What Happens When You Close an Account?

When you close an account, your credit reports will reflect the account’s new status. But information about the closed account — including how much you borrowed and your payment history — may still be used to calculate your credit score and inform lenders about your overall creditworthiness.

Even if you’ve paid every penny you owe, the account still may be included in your reports. And if you have an outstanding balance, you can expect payments and other activity to show up on your reports every month.

The Fair Credit Report Act — the federal law that regulates how consumer credit agencies handle and report information — allows the credit bureaus to include positive and negative information about closed accounts on a credit report for several years.

Recommended: Should I Sell My House Now or Wait?

How Can Closed Accounts Affect Your Credit?

Closing an account can affect your credit in ways both good and bad. Here’s a look at what can happen in the months and years after you close an account.

An Unexpected Credit Score Dip

Something that surprises a lot of people is that closing an account can actually have a negative impact on credit scores — even if the account was in good standing. That’s because closing an account can affect certain factors that go into calculating your FICO Score. The dip may be temporary (as long as you stay on track with managing your debt), but here’s what’s behind it:

Credit Utilization Ratio

Your credit utilization ratio represents the amount of your available credit that you’re currently using. It’s part of the “amounts owed” category, which determines 30% of your FICO Score.

If you close an account and the amount of credit available to you is reduced, that can affect your ratio. And a higher credit utilization ratio can mean a lower credit score.

Length of Credit History

Closing a long-held credit card account can also affect the “length of credit history” category, which accounts for 15% of your FICO Score. FICO looks at the age of your oldest account, the age of your newest account, and the average age of all your accounts. So closing an older account after you pay it off can lower your score.

Credit Mix

FICO also looks at your “credit mix” when it’s calculating your overall score, so it can help if you have both revolving debt (with a credit card or line of credit) and some type of installment debt (such as a student loan, personal loan, car loan, or mortgage). Your credit mix is 10% of your FICO Score.

Recommended: What Credit Score Is Needed to Buy a Car?

But There May Be Good News, Too

Should you still decide to close your account, there is some happy news: If you did a good job managing that particular credit card or loan, the information can stay on your credit reports for up to a decade, continuing to boost your credit score. However, the bump from a closed account may not be as significant as from an open one.

When Should You Remove a Closed Account from Your Credit Report?

Since information about a closed account in good standing can be a positive thing for both your credit reports and credit scores, you may decide it makes sense to bask in those benefits for as long as possible.

But if your closed account is littered with negative information that could make you look like a risk to lenders and potentially lower your credit scores, you may want to attempt having it removed from your credit reports. Any negative information — if you made late payments, defaulted, or the account went to collections — will stick around, and can lower your score for up to seven years.

There are a few different strategies you can try. If, for example, the closed account contains inaccurate or fraudulent information, or if the information is dated, you have a right to pursue having it removed. If you suspect that you’re a victim of identity theft, you may want to learn the differences between a credit lock vs. a credit freeze.

But if the negative information is accurate, you may have to appeal to that creditor to help you clean up your record. Or you can decide to wait it out, and the closed account will eventually come off your report.

Recommended: How to Remove Student Loans From Your Credit Report

Steps for Removing a Closed Account from Your Credit Report

There are four basic strategies for removing a closed account from your credit report.

Dispute Errors on Your Credit Report

If you believe your credit report includes inaccurate, incomplete, or fraudulent information on an open or closed account:

Contact the Credit Bureaus

First, review the data on file with all three credit reporting agencies: Experian, Equifax, and Transunion. (Or request a tri-merge credit report that combines the data from all three.)

Then contact the credit bureaus and explain why you’re disputing the information and include supporting documents. All three bureaus have a page just for this purpose on their website. Or you can download a dispute form, fill it out, and mail it in. Either way, following the recommended format will help ensure you include all necessary data.

Recommended: What Is The Difference Between Transunion and Equifax

Contact the Company That Furnished the Information

Contact the bank, credit card company, or business that provided the disputed information to the credit bureaus. The Consumer Financial Protection Bureau (CFPB) offers instructions and a sample letter to assist with this process. If you suspect the inaccurate information could be the result of identity theft, you can find help through the Federal Trade Commission at IdentityTheft.gov.

Wait for a Fix

The credit bureaus typically have 30 calendar days (45 in some situations) to look into your dispute. Once the investigation is complete, they have five business days to let you know, and you should receive a copy of your updated credit report.

If they don’t agree the information should be removed, you can send a letter and ask that they note the dispute on future reports. You also can send a complaint to the CFPB or contact an attorney.

Write a Goodwill Letter or Pay-for-Delete Letter

Although a creditor isn’t required to remove negative information from your credit reports, you can try writing a goodwill or pay-for-delete letter asking for their help.

Not much of a writer? You can try calling instead. Either way, be prepared to plead your case clearly and respectfully.

Goodwill Letter

A goodwill letter can give you an opportunity to explain to a creditor why you fell behind on your payments and why you’re hoping to get the negative information removed from future credit reports.

If you’ve been a long-standing customer (or can manage to write a heartstring-tugging letter), you may be able to convince the financial institution or business to help you turn over a new leaf.

Pay-for-Delete Letter

If the closed account still has a balance, you may be able to use a pay-for-delete letter as an incentive to get it removed from your credit reports. This strategy involves offering to pay the outstanding balance in exchange for getting the account off your reports.

Wait for the Account to Come Off on Its Own

It may feel like a lifetime, but negative information can be listed for only seven years. So you may decide just to wait it out.

If the information is still on your reports after the seven-year mark, you can use the dispute process to have it removed.

Establishing Healthy Credit Habits for the Future

Watching your credit score take a dip after you close an account can be frustrating. But practicing good financial habits going forward can go a long way toward bolstering your credit scores. Here are a few steps to consider:

Make Timely Payments

Payment history makes up 35% of your FICO Score, so if you want to boost your score, it’s critical to pay your bills on time.

Keep Your Credit Utilization Low

Because credit utilization is another important factor that goes into calculating your credit score, it’s a good idea to keep credit card balances low. Don’t let a high limit on a card or line of credit tempt you into spending more than you can manage.

Let Your Credit Accounts Age Gracefully

It may be tempting to cancel a credit card you’ve finally managed to pay off. But since your credit score is partially based on the age of your accounts, it may make more sense to keep open an account that’s in good standing.

Track Your Spending

If you like the convenience of using credit and debit cards to pay for purchases, but you tend to lose sight of your spending, a money tracker app like SoFi can help you see exactly where your money is going, so you aren’t just winging it month to month.

Monitor Your Credit

If you aren’t monitoring your credit, you may not have any idea what your credit score is. By using an app like SoFi, which has free credit monitoring, you can check your score regularly. You also can request a free copy of your credit report once a year from each of the three credit bureaus via AnnualCreditReport.com.

Be Vigilant Regarding Credit Report Errors and Fraud

In order to dispute problems on your credit report, you have to know what to look for. Learning how to read your credit report can help save you from more serious financial trouble.

Familiarizing yourself with the various sections might help you spot common credit report errors and potential fraud.

The Takeaway

Closed accounts aren’t automatically removed from credit reports. The credit bureaus may keep information from a closed account on your reports for years: seven years for negative information and ten years for positive info. However, you can request to have the account removed if you file a dispute and can show the information is inaccurate. Other strategies include writing a “goodwill” letter, a “pay-to-delete” letter, and contacting the creditor directly. It’ll take time, but persistence often pays off.

Take control of your finances with SoFi. With our financial insights and credit score monitoring tools, you can view all of your accounts in one convenient dashboard. From there, you can see your various balances, spending breakdowns, and credit score. Plus you can easily set up budgets and discover valuable financial insights — all at no cost.

FAQ

Can you remove a closed account from your credit report?

Unless information about a closed account is inaccurate, it may appear on your credit report for years. But there are strategies that can help you with getting the information removed or updated.

How long does it take for a closed account to be removed from a credit report?

It can take up to seven years for negative information from a closed account to come off a credit report. And it can take up to 10 years before positive information goes away.

Will paying off a closed account help a credit score?

Your credit reports will continue to include negative information about a closed account for up to seven years. But if you follow through and pay off the debt, the change in the account’s status can be noted on your reports. And if you’ve lowered the amount of debt you’re carrying by paying off the account, it can help improve your credit score.

Photo credit: iStock/fizkes

SoFi Relay offers users the ability to connect both SoFi accounts and external accounts using Plaid, Inc.’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. Based on your consent SoFi will also automatically provide some financial data received from the credit bureau for your visibility, without the need of you connecting additional accounts. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score is a VantageScore® based on TransUnion® (the “Processing Agent”) data.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SORL-Q324-034

Employers can approach background checks in different ways. In some cases, credit reports are included. A job background check may include a credit check in certain industries, such as banking and security. The size of the company can be a factor, too: Large corporations are more likely to conduct a credit check than a small family business.

We’ll walk through the specifics of when an employment background check may include a credit check, why potential employers want this information, and what financial data they have access to.

What Are Credit Checks?

A credit check is a request to see your financial data as collected by one of the three major credit reporting bureaus: Equifax, Experian, and TransUnion. Credit reports contain information about past and existing credit accounts, payment patterns, and how much debt you’re carrying.

According to the Fair Credit Reporting Act (FCRA), only certain individuals and organizations have the right to check credit histories, such as lenders, insurance agents, and landlords. Potential employers can also conduct a credit check for employment purposes, with your permission.

Sometimes credit checks are conducted to confirm a consumer’s identity — and head off identity fraud — rather than to investigate your financial history. For instance, banks may run a limited credit check on customers looking to open a checking account.

Credit Check vs Background Check

A background check contains identification verification information along with data from criminal records, educational and employment backgrounds, civil records, driving history, and more. In some instances, a background check may also contain a credit check.

The Importance of Good Credit

A good credit history primarily makes it easier to get approved for a loan and to qualify for better interest rates and loan terms. The higher the score, the less someone will pay in interest over their lifetime, potentially saving them money in the long run.

Good credit can also help renters qualify for an apartment. In some cities, renters routinely provide a credit reference with their rental application. While there’s no minimum credit score needed to rent an apartment, a strong credit history shows landlords that you’re someone who pays their bills on time.

Employers may also check your credit if you’ve applied for a job. Having good credit without any red flags can make the hiring process go more smoothly. However, some cities and many states have banned this protocol or put limits on it.

Recommended: Should I Sell My House Now or Wait?

Why Employers Look at Your Credit Score

An employer may run a credit check on a job applicant whom they’re seriously considering hiring. Employer credit checks are more common in industries where employees handle money or have access to customers’ financial data.

By conducting credit checks, businesses hope to confirm that an applicant demonstrates financial responsibility and doesn’t pose a security risk to the company, other employees, or customers.

Responsibility

A credit report shows how responsibly an applicant has handled their own money. If there are any red flags, the employer may not want to hire that person to handle company funds or take on other important responsibilities.

Security

A credit report can be used to verify your identity along with other pieces of background information. If there are discrepancies that can’t be easily cleared up, that’s a red flag.

What a Credit Report May Tell an Employer

The information in a credit report can include employment history as well as red flags such as late payments, debts sent to collections, foreclosures, liens, lawsuits, and judgments.

Employment History

Your complete employment history is not included in a credit report. Past and current employers may appear on your credit report, but only if you listed them on a loan or credit card application. Typically, if a lender wants your employment history, they will ask you for it directly.

Late Payments

Credit reports contain information about current and historical credit accounts, including installment loans (mortgages, car loans, personal loans) and revolving credit (credit cards and lines of credit). The reports typically contain information from the past seven to ten years, including a person’s payment history and whether credit accounts are paid up to date or are past due.

Debt Collection

Once someone is behind on payments — at least 120 days — the lender may send the account to a collections agency. These agencies attempt to collect on the bill. This can have a significant impact on your credit score, since making payments on time is the biggest factor in the algorithm that determines your credit score.

Debt Charge-Off

If a company you owe money decides they can’t collect the funds, they can “charge off” the amount as uncollectible. This may stay on your credit report for seven years, starting with the delinquency date that ultimately led to the charge-off. A debt charge-off typically lowers the person’s credit score even more than going to collections.

Foreclosures

When a homeowner misses multiple mortgage payments, the lender may take possession of the home, or “foreclose” upon it. This remains on a credit report for seven years, starting with the first missed payment that ultimately led to the foreclosure. This can significantly reduce someone’s credit score — although the impact may diminish over time — and can be a red flag for employers.

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Liens

A tax lien is a claim that you owe money for taxes, usually federal, state, or property tax. Tax liens no longer appear on credit reports by the three major credit bureaus, and they can’t affect your credit. They are, however, available on public records. If an employer conducts a full background check, they can still receive this information.

Lawsuits and Judgments

Just like tax liens, judgments from lawsuits are not included in credit reports or factored into a credit score. An employer that conducts a background check, though, will likely receive this information because it’s part of public records.

How to Prepare for an Employer Credit Check

Every consumer should be aware of what information is available on their credit report. You can request your credit report and find out your credit score for free at AnnualCreditReport.com.

Review your report for errors. Even small typos — like misspelling your name — could present problems down the line. Report inaccuracies to the relevant credit bureaus via their online dispute process to have them corrected or removed.

You may also consider signing up for a credit monitoring service. What qualifies as credit monitoring varies from company to company. Look for a service or a money tracker app that sends customers alerts whenever their credit score changes, accounts are opened or closed, and red flags appear on their credit history.

If you’ve had financial problems in the past but have turned things around, be prepared to explain to your potential employer how you’ve accomplished that.

Recommended: What Is a Tri-Merge Credit Report?

Credit Check Limitations

Credit reports contain a lot of private financial information. However, you can feel secure knowing that there are strict limits to what can be included. The following information cannot appear on your credit report:

•   Account balances for checking, savings, and investments

•   Records of purchases made

•   Income information

•   Judgments and tax liens

•   Medical information (physical and mental), although money owed to a doctor or hospital can appear

•   Marital status

•   Disabilities

•   Race and ethnicity

•   Religious affiliations

•   Political affiliations

Does an Employer Credit Check Hurt Your Credit Score?

No. Employers conduct what is known as a “soft credit inquiry” or soft pull. Because the credit check isn’t the result of applying for a new loan or credit card, the request probably won’t appear on your credit report and it won’t affect your score.

What Are Your Legal Rights as a Job Applicant?

According to federal law, job applicants have the right to:

•   know what is in their file

•   ask for a credit score

•   dispute incorrect or incomplete information

•   be told if information in the file is used against them

An employer or potential employer must get written consent before they can request credit report information (the trucking industry is an exception). Some cities and many states have banned or put limits on an employer’s ability to check your credit report.

The Takeaway

Employers may run credit checks on applicants as part of the hiring process. By conducting credit checks, businesses hope to confirm that an applicant demonstrates financial responsibility and doesn’t pose a security risk to the company, other employees, and customers. Credit checks are more common at large corporations and in industries where employees handle money or have access to customers’ financial data. You can prepare for an employer credit check by requesting your report and correcting any errors. You may also want to use a credit score monitoring service to keep tabs on any changes.

Take control of your finances with SoFi. With our financial insights and credit score monitoring tools, you can view all of your accounts in one convenient dashboard. From there, you can see your various balances, spending breakdowns, and credit score. Plus you can easily set up budgets and discover valuable financial insights — all at no cost.

FAQ

Why do background checks include credit reports?

Information found in a credit report can give the employer a sense of the job applicant’s financial stability. This may be especially important if the job involves handling money, financial data, or pharmaceuticals. Some industries that routinely pull credit checks on applicants include banking, retail, insurance, public safety, and security.

Does a background check include a hard credit check?

No. A background check with a credit check involves a soft inquiry, so it won’t affect your credit score.

What causes a red flag on a background check?

Criminal records, suspicious credit histories, inconsistencies in information provided, and gaps in employment history can be considered red flags in a background check.

Photo credit: iStock/serggn

SoFi Relay offers users the ability to connect both SoFi accounts and external accounts using Plaid, Inc.’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. Based on your consent SoFi will also automatically provide some financial data received from the credit bureau for your visibility, without the need of you connecting additional accounts. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score is a VantageScore® based on TransUnion® (the “Processing Agent”) data.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Although Experian is the largest credit bureau in the U.S., TransUnion and Equifax are widely considered to be just as accurate and important. When it comes to credit scoring models, however, there is a clear winner: FICO® Score is used in roughly 90% of lending decisions.

It’s crucial that consumers understand at least the basics of how credit reports work and credit scores are calculated. After all, a high credit score can get borrowers the best deals on loans and credit cards, potentially saving them many thousands of dollars over a lifetime. Read on to learn how you can build a credit history that lenders will swoon over.

Will My Credit Score Be the Same Across the Board?

In a word, no. Credit scores vary depending on the company providing the score, the data on which the score is based, and the method used to calculate the score.

In an ideal world, all credit bureaus would have the same information. But lenders don’t always report information to every bureau, so there will be variations in your credit file — usually minor — from bureau to bureau.

How Are Credit Scores Calculated?

Regardless of the scoring model used, most credit scores are calculated with a similar set of information. This includes information like how many and what types of accounts you have, the length of your credit history, your payment history, and your credit utilization ratio.

Lenders like to see evidence that you have successfully managed a variety of accounts in the past. This can include credit cards, student loans, personal loans, and mortgages, in addition to other types of debts. As a result, scoring models sometimes include the number of accounts you have and will also note the different types of accounts.

The length of your credit history shows lenders that you have a record of repaying your debts responsibly over time. Scoring models will factor in how recently your accounts have been opened.

Your payment history allows lenders to see how you’ve repaid your debts in the past. It will show details on late or missed payments and any bankruptcies. Scoring models typically look at how late your payments were, the amount you owed, and how often you missed payments.

Each scoring model will place a different weight of importance on each factor. As an example, here are the weighting figures for your base FICO Score:

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Which Credit Score Matters the Most?

As noted earlier, the credit score that matters the most is generally your FICO Score, since it’s used in the vast majority of lending decisions. There’s really no way to determine which credit score is most accurate, though, because they all use slightly different scoring models to calculate those precious three digits.

Even within your FICO Score, there’s variation. The most widely used FICO Score is FICO 8 (though the company has released a FICO 9 and FICO 10). This differs from previous versions in key ways:

•   Credit utilization is given greater weight.

•   Isolated late payments are given less weight than multiple late payments.

•   Accounts gone to collections for amounts less than $100 are ignored.

In addition, FICO can tweak their algorithm depending on the type of loan you’re applying for. If you’re looking to get an auto loan, your industry-specific FICO Score may emphasize your payment history with auto loans and deemphasize your credit card history.

As you can see, slight differences in method can result in different credit scores even given the same source data.

What Are the Largest Three Credit Bureaus?

The three major credit bureaus are Experian, Equifax, and TransUnion. These bureaus collect and maintain consumer credit information and then resell it to other businesses in the form of a credit report. While the credit bureaus operate outside of the federal government, the Fair Credit Reporting Act allows the government to oversee and regulate the industry.

It’s worth noting that not all lenders report to the credit bureaus. You may have seen advertisements for loans with no credit check. Lenders that offer this type of loan won’t check your credit, and typically don’t report your new loan or your loan payments to the credit bureaus. Because these loans are riskier for the lender, they can justify high interest rates (possibly as much as 1000%) and faster repayment schedules. Consumers should beware of predatory lenders, especially risky payday loans and other fast-cash loans.

How To Find Your Credit Score

Your credit history and score play a large role in your personal finances. They can impact everything from taking out a mortgage or renting an apartment to buying a car and refinancing your student loans. Having an idea of what your credit score is can help you determine what your loan may look like and how much you can afford to borrow.

You can request a free copy of your credit report from each of the major credit bureaus at AnnualCreditReport.com. Typically, your credit reports will not contain your credit scores. However, you may be able to access your FICO Score for free through your bank or credit card company (it may be on your statement or you may be able to see it by logging into your account online). You can also purchase credit scores from one of the three major credit bureaus or FICO. Some credit score services offer free scores to any user, while others only offer sores to customers who pay for credit monitoring services.

Be careful when you pull your free credit reports not to accidentally opt in to an add-on service that will charge you for special tools or credit monitoring.

Building Strong Credit

Credit scores aren’t set in stone. They evolve constantly as new financial information comes in, both positive and negative. Here are some strategic steps to consider for those trying to build a positive credit history:

Make Payments on Time

This includes credit card payments, rent, loans, utilities, and any other monthly bills or payments. Lenders often consider past behavior to be a predictor of future behavior and want to avoid lending money to individuals with a history of missed payments.

Pay Down Revolving Credit

Revolving credit refers to credit cards and credit lines, such as home equity lines of credit (HELOCs). Lenders generally like to see that you use no more than 30% of the total revolving credit available to you. It’s an indicator that you are able to effectively manage your credit.

One popular way to pay down high-interest revolving debt, is to use a debt consolidation loan. These are unsecured personal loans that typically offer lower fixed interest rates compared to credit cards. Getting approved for a personal loan is fairly straightforward, and you can usually shop around for the best personal loan interest rates without it affecting your credit score.

Be Selective About New Accounts

Opening a new credit card or applying for a loan generally involves a hard credit inquiry. Too many hard credit inquiries can have a negative impact on the applicant’s score. So while having a diverse mix of credit is a good thing in the eyes of lenders, opening a number of new accounts at once may be counter-productive.

The Takeaway

All three major credit bureaus — Experian, Equifax, and TransUnion — are more alike than they are different, and any variations in their data are usually minor. Equifax is the largest credit bureau in the U.S., but TransUnion and Equifax are thought to be just as important. When it comes to credit scores, however, lenders prefer FICO Score by a wide margin.

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