Here's the simplest and most illuminating way I know to describe it. Key principle:
- All credit profiles are penalized if they have no open installment loans of any kind, or if they do but the total amount they owe on installment debt is very close to the total amount they originally borrowed. Both situations involve being penalized, even if the person doesn't realize it.
When a person has a single open installment loan, he is gradually paying more and more of it off. In the last few months of the life of the loan, he has gotten to a place where almost all of his installment debt has been paid off. Let's use a $20,000 car loan or a $20,000 student loan as an example. At first you owe almost the entire 20k. The percentage you still owe on your open debt is high: close to 100%. But in the last few months of the life of the loan, you may only owe (say) $1000. The percentage you owe on your open debt is very low: about 5%.
At the end of the life of your loan, FICO is rewarding you for having an open loan, and is also rewarding you for having paid off most of that open loan.
When the loan closes, you are no longer getting FICO points for either thing. That appears at the time to be a "hit", but in fact it is the normal state of FICO scoring when you have neither gold star going for you.
The solution that people here have found is to open what is called a Share Secure loan. The loan can be quite small ($500 is fine) but it should be for a term of 4 years, longer is better. A couple months after opening it, you then pay off most of the principal (but not all) and then keep the loan open for the full term of the loan. The result is (very quickly) an installment loan on your reports that appears to be mostly paid off, and since most of the principal is paid off, you pay very little interest. Alliant is one lender that appears very cooperative with this approach.
Note that this nice little technique helps you if (a) you need the extra points and (b) you are fairly sure you aren't about to be getting another big installment loan (like a 20k auto loan), If you get a big car loan, then the fact that the Share Secure loan is mostly paid off will be largely overwhelmed by the fact that the auto loan is not. Some people choose to not worry about adding the Share Secure loan until later, closer to when they need the extra points.
Let me know if this makes sense.
PS. If it seems like FICO is not giving you any scoring benefit for having successfully managed and paid off an installment loan over time, that's not true. You do get some scoring benefit for having successful closed installment loans. It's just that, for good or ill, the principles above still apply and the latest FICO models like it when you have some open installment debt that is mostly paid off.
