Drivers looking to get a car loan often want to know how it will affect their credit. So, does a car loan build credit or does it lower your score?
By itself, a car loan does not build credit. However, you can use the car loan to help boost your score by making payments on time.
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How does a car loan affect credit?
The act of opening a car loan will affect your credit score. At first, you may see your credit score drop slightly. This is the effect of lenders performing a hard credit check, which allows them to calculate your interest rate and other loan terms.
Any credit inquiries made for a car loan will appear on your report. However, most credit bureaus combine several inquiries so they only count as one. Even if you apply for a few car loans in a short period of time, it shouldn’t significantly affect your score.
Once you start making loan payments, your credit score should recover. And by keeping up with your monthly loan payments, your credit score should go up in the long run.
However, having a car loan can hurt your credit score if you are inconsistent with your payments. If you’re more than a month late on a payment, or you consistently miss the deadline, you can expect your credit score to drop. Plus, if you don’t communicate with your lender, you could be at risk of having you vehicle repossessed.
Factors that affect your credit score
Your credit score determines how “creditworthy” you are, which essentially shows how responsible you will be to a lender. There are several factors that affect your credit score.
Your payment history is one of the most important factors affecting your credit score. It makes up 35% of your total FICO score, which lenders use the most. For this reason, it is important to make timely payments for loans and credit cards. If you fall behind on your payments, your credit score will drop.
Credit utilization ratio
Your credit utilization ratio counts up to 30% of your credit score. This is used to compare your total outstanding debt with your total credit limit. Your outstanding debt is the amount of money you owe, while your total credit limit is the maximum amount of money you can borrow.
Length of credit history
When it comes to length of credit history, older is better. This is why you should always keep credit cards open, whether you use them or not. The length of your credit history makes up about 15% of your score.
New accounts affect 10% of your score. Opening up multiple loans or credit cards over a short period of time can have a negative impact on your credit score. Be careful when opening new accounts and avoid opening too many accounts close together.
Tips to improve your credit score
One of the best ways to improve your credit score is to be consistent with your debt repayments. It’s not limited to your monthly auto loan payment either. Paying your bills on time each month will slowly improve your credit. While there is no quick way to fix a bad score, being responsible with your payments will certainly help.
In addition to keeping track of your payments, it’s a good idea to keep a few credit accounts open. For example, if you have a credit card that you opened years ago and never use, consider keeping it open. As long as it is not exhausted, an active account is a good way to establish a long credit history.
You also want a healthy mix of bills, like auto loans and mortgages, and revolving credit, like credit cards. However, do not apply for all these accounts at the same time. An influx of credit applications can raise a red flag to lenders and credit bureaus, which can have a negative impact on your score.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with over three years of experience covering personal finance and insurance. She has extensive knowledge of various lines of insurance, including auto insurance and property insurance. Her byline has appeared in dozens of online finance publications, such as The Balance, Investopedia, Reviews.com, Forbes and Bankrate.