What happens when I pay off the loan?

With just a few more payments left on your loan, you’re ready to celebrate. But before you close your account, you need to know what happens next.

Disbursement of a personal loan is not simply the last click on “Submit Payment”. It affects your credit profile, your monthly budget, and even your long-term financial plans. If you hit the bottom line without a strategy, you could be leaving potential gains behind.

Here’s what happens when you pay off a personal loan, how it affects your credit score, and how to use the money you free up wisely.

Paying off your loan is a win, but the transition can come with changes that you’ll want to be prepared for.

Paying off a personal loan does not affect everyone’s credit score equally. Some people see a slight drop, some see no change, and some see a slight bump.

Your score is most likely to go down if a personal loan is your only payment. Credit scoring models favor a combination of credit types, both revolving credit (such as credit cards) and installment credit (such as personal or auto loans). If you pay off your only loan, you will lose that credit balance.

“When you close an active account, it changes things a little bit like your credit mix, your credit age, and your ongoing positive payment activity,” said Melissa Cox, a certified financial planner (CFP) at Future-Focused Wealth in Dallas. “This can cause the algorithm to drift by a few points.”

According to the credit data analysis company FICO, borrowers with small installment loan balances are less risky than borrowers with no active installment loans. For this reason, your score may drop slightly when you pay off your last loan payment.

However, for most people, this drop is small and temporary. Think 5 to 10 points if you already have decent credit, Cox said.

Remember, paying off a personal loan ultimately improves your credit score—assuming you’ve made (and continue to make) your payments on time.

“You’ve reduced your debt, freed up your cash flow, and shown that you can manage credit responsibly,” Cox said. “It’s a long-term victory, even if the result takes a moment.

Those positive on-time payments can also stay on your report for up to 10 years, and any late payments or interest charges usually fall off after about seven years. According to Equifax, one of the nation’s three consumer reporting agencies, if your score drops, you can expect it to rebound about 30 to 45 days after the loan is paid off.

The most important step is to wait for it to fall so it doesn’t hit you. “Don’t let a little drop distract you from the big milestone,” Cox said.

Learn more: Here’s how to check your credit score for free

Your debt-to-income ratio (DTI) compares your monthly income to your monthly debt payments. Lower is always better.

Lenders check this ratio when deciding whether to lend you money. Once you pay off your personal loan, your DTI improves immediately. This is useful if you plan to:

Even if you don’t currently intend to take on new debt, a lower DTI gives you more options and flexibility. This means that your paycheck isn’t destroyed by debt payments, and you have more flexibility to deal with surprises or opportunities.

A low DTI also helps you look better to lenders. As a result, you can start getting lower interest credit cards, personal loans, and even refinancing options.

“Used wisely, a stronger credit profile can open the door to better financial opportunities,” Cox said.

But think twice before signing up. “Just because it’s offered doesn’t mean it’s right,” Cox said. “Especially after working hard to pay something off, the last thing you want is to go back into debt.”

3. Maintain records and check your credit report

After the last payment notices, your lender should send you confirmation that your loan balance is officially paid.

Keep this document in a safe place (preferably physical and digital copy). If there is ever a reporting error or system failure on your credit report, this is your proof.

You should also:

• Check your credit report about 30-60 days after the payout to make sure the account is marked as “closed.” If you have never missed a payment, the account may be marked as “paid in full”. If you’ve been late on your payments or refinanced your loan, it might say something else, like “paid; 30 days past due.”

• Keep an eye out for any random automatic payment withdrawals in your next billing cycle.

These steps may seem tedious, but ultimately they are a way to protect yourself if your credit report and lender records don’t match up.

Once that monthly personal loan payment is gone, you’ll have more financial room. But without a clear plan, that money can easily disappear into everyday expenses. That’s why it’s so important to decide what to do with those funds against your final payment has cleared.

Some recommended ways to use this money are:

• Boost your retirement contributions with a 401(k) or IRA.

• Roll the payment over to another debt and help speed up your payoff (and save money on interest).

• Build your own emergency fund, especially if you have less than three to six months of expenses saved up.

Setting up automatic transfers is a great way to make sure your money goes where you want it to, said Scott Oeth, CFP and principal at Cahill Financial Advisors in Minneapolis.

“Put a good plan on autopilot,” he suggested. This set-it-and-forget strategy can help protect your future.

“Automation means you only have to make a decision once, rather than relying on your future self to avoid temptation,” Oeth said.

Your budget has already survived without that money—keep the habit going with other financial goals.

If you intend to repay the loan early, there are a few additional things to keep in mind.

First, check for prepayment penalties. Some lenders charge these fees to make up for the interest payments you avoid by paying off your loan early. Fortunately, few lenders charge this fee, said Kevin Feig, CFP and founder of Walk You To Wealth.

“Prepayment penalties aren’t common on personal loans, so it usually makes sense to pay off your personal loan as soon as possible,” Feig said.

Details of prepayment penalties (if applicable) will be specified in the personal loan agreement. If you can’t find your contract or understand what it says, call your lender and ask directly.

If your lender doesn’t charge a penalty and you have a healthy emergency fund, paying off a personal loan early can be a smart decision. You’ll save money on interest, plus you’ll get extra wiggle room back into your monthly budget sooner.

But if paying off the loan will wipe out your savings, slow down. Being debt-free doesn’t help if one unexpected expense can wipe you out and put you right back where you started.

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This article was edited by Alicia Hahn.