How Much a Car Loan Will Affect my Credit Score?

October 10, 2024

“Will getting a car loan affect my credit score?” I know you are worried, and this is one of the many questions in your mind.

Do you know you can get a car loan without affecting your credit score? I know you won’t believe me until you read this post up to the end.

However, before buying your dream car, you must understand how a car loan affects your creditworthiness.

The better part? It can work in your favour if you pay up on time and manage your loan well.

How about the worst part? Managing it poorly dents your credit score, especially when you want to go for new credit applications.

You need to know how all these happen so that you can determine whether to apply for credit or not.  And that is what this article is all about.

Key Takeaways

Here are the key points that will be discussed:

• How taking a car loan can affect your credit score in various ways.
• We will also discuss how timely payments can improve your score
• How credit score can be affected if you miss the repayment.
• You will learn the various factors that affect how much your credit score changes when taking a car loan.
• How you can make informed financial decisions when you understand the credit score effects.

What Factors Determine How a Car Loan Affects Your Credit Score?

When you apply for a car loan, it will affect your credit score. Your score increases when your credit mix has a new credit added to it. However, there will be a dip when you take out a new debt.

Now, let’s discuss each factor one by one. We will see how each one can affect your score, both positively and negatively.

How Payment History with a Car Loan Influences Credit Score

One of the most vital factors for your score is payment history. If you pay all your debts on time, applying for a car loan can help your credit score. It builds your repayment history and credit history. Making payments on time can greatly improve your credit score.

However, if you fail to make your payment when due, it will remain on your credit history for up to 7 years. Additionally, your lender can even claim back the vehicle if your loan payment is over thirty days late.

Credit Utilization Impact of a Car Loan

A car loan affects your credit score differently than credit cards do. Car loans don’t count toward your credit utilization, which makes up about 30% of your credit score. Let us assume that you have three credit cards. Each has about a $4,000 credit limit, meaning $12,000 is your available credit.

Taking a car loan will not increase the limit on your credit card. Rather, your debt will increase. If your total loan is $15,000, then your debt will increase by $15,000. This will also increase the monthly debt payments for your car loan payment.

Credit Mix and the Role of a Car Loan

Having a diverse credit mix will prove to your lenders that you responsibly use credit in different circumstances. Some common credits that show in a credit mix are mortgages, auto loans, credit cards, and student loans. Credit could be open, instalment, or revolving.

Most consumers have only different credit types, like student loans and credit cards. Some even have only one. An auto loan can benefit you if it is an instalment credit, as it will improve your credit mix. If you pay all your debts on time, your credit score will improve if you have revolving, instalment, or open credit.

New Credit Inquiries from Applying for a Car Loan

If you check your credit score multiple times for an auto loan within 14 to 45 days, it counts as one inquiry. That said, each hard inquiry can lower your score.

This impact is usually temporary; your score typically rebounds within a few months. Hard inquiries only affect your credit score for one year, even though they remain on your report for two years.

How Car Loans Affect Length of Credit History

The length of your credit history can determine whether your credit score will improve or not. Ensure you leave open your oldest credit account whenever you want to apply for a car loan. This will help to prevent your score from dropping.

Short-Term vs. Long-Term Effects of a Car Loan on Credit Score

When you submit credit applications, your credit score will be negatively affected in the short term. Why? Your lender will perform a hard inquiry check on your credit, and this can reduce your score by up to five points. But just as we have rightly mentioned, this negative effect is only temporary.

When you pay your car loans on time, your credit will improve. This can positively affect your credit score in the long run.

One of the things that can help you pay your car loans consistently is staying ahead of your payments. If it is possible, you may decide to pay 2 months ahead.

This way, even if an emergency comes up, your credit will still be safe. The goal is to avoid missing a payment and avoid the car loan default effect on credit to keep your score healthy.

Can Taking a Car Loan Improve My Credit Score?

How much a car loan will affect your credit score positively depends on how you reliably pay off your loans. Here is how taking a car loan can boost your credit score:

Building Credit History Through a Car Loan

Your payment history ranks as one of the most important factors when someone calculates your credit score. Your payment history accounts for up to 35 per cent of your FICO Score.

So, when you regularly pay your auto loan on time, your credit score may improve over time. Try as much as possible to avoid making late payments, as this will help to protect your score.

How a Car Loan Can Diversify Your Credit Mix

When a car loan is added to your credit report, it could positively affect your credit. This is because credit scoring models look at how you manage different types of credit. This includes revolving credit and instalment credit. Credit mix makes up 10% of the FICO score, which shows its importance.

Making on-time payments when taking out a car loan is crucial. Forgetting your payments is always easy because of the multiple bills that you dare pay.

It might be a good idea to set up auto-pay. This way, you won’t miss any payments. Keeping up with payments helps your credit score stay strong. You will avoid any negative marks on your credit file.

Risks and Downsides: How a Car Loan Can Lower Your Credit Score

Applying for a car loan could temporarily reduce your credit score. When you apply, your lender checks your credit, and they refer to this process as a hard inquiry.

Once this happens, you will temporarily see a reduction in your credit score. But there is more. After you receive the car loan, you can negatively impact your credit score if you fail to manage it properly.

If you fail to pay on time or you miss your payments, this can negatively affect your scores. High interest rates can also increase financial strain, impacting your scores negatively. Here are some ways in which a car loan can lower your credit score:

Defaulting on a Car Loan and Missing Payments:

Lenders consider you a defaulter if you fail to pay for your can loan for over 30 days. When you default, there can be severe consequences. Repossessors could take your car, and your credit score could suffer severe negative impacts.

This information will remain on your scores and credit reports for 7 years. Now, qualifying for future loans or credit becomes an uphill task. If you miss any other payments after this, you will severely harm your score.

Tips for Managing a Car Loan to Minimize Negative Credit Impact

Managing debt responsibly is vital to maintaining a positive car loan impact on credit score. Repaying the loan may be a weighty task as it might take many years.

But, with proper management, you can clear off your debt and minimize negative credit impact. Here are some practical tips that can help you to keep your credit score impact as positive as possible:

Budgeting for Monthly Payments on a Car Loan

Improving your credit score with a car loan is highly possible. The first and most crucial step is to create a budget. You need to know whether you can make the monthly payments.

Create a list of your monthly expenses, like utilities, food, and rent. Then, include your car loan payment. Once you are sure that you can keep up with these monthly payments, including your car loan, you can proceed.

Setting Up Autopay for Car Loan Payments

Humans tend to forget. So, to avoid forgetting to pay your car loan, setting up automatic payments will be a good idea. However, you should try as much as possible to ensure you have enough funds to cover the payments to avoid overdraft fees.

Choosing Affordable Loan Terms to Reduce Risk

Choose a loan term that is more affordable for you. Some people may prefer a short-term loan as it attracts lower interest rates. If this comfortably fits your budget, you may consider going for it. Although you may need to make higher monthly payments, it will also help you make significant savings overall.

How Different Loan Terms Affect Your Credit Score Impact

Your car loan terms and interest rate affect your credit score in different ways. Let’s compare short-term and long-term loan terms and see how they can impact your credit score.

Short-Term vs. Long-term Car Loan Terms

Going for a short-term loan can be a good idea if you plan to repay your loan quickly. Here is what you should expect for a short-term auto loan:

• Higher monthly payment: The monthly payments will be higher since you have just a little time to pay off the short-term car loan. So, you should consider your budget before deciding whether to go for a short-term loan.
• Lower interest rates: There is a lower risk of defaulting during a short-term loan period. For this reason, you may score an exceptionally low interest rate.

Long-term loans will give you more time to clear off your debt. But this could mean you may need to pay more for your vehicle over time. Here is what comes with a long-term car loan:

• Higher interest rate: For long-term loans, borrowers will most likely default over time, which creates more risks for the lenders. To compensate for the risk, lenders charge higher rates.
• Lower monthly payment: When you stretch your loan payment over a longer period. It means that your monthly payments will be lower.

Will Paying Off My Car Loan Early Help My Credit Score?

Here is what you need to know about loan payoff and credit rating:

Paying off your auto loan early is usually a good idea. This is especially true if you have no other urgent expenses or high-interest debt. But, if you have other better things to use the money for, it might not be ideal to pay off the loan early.

Paying off your auto loan early can affect your credit score in some ways. For example, you could lose some points if your account is your only active loan. However, clearing the debt might have a positive and bigger impact. Let us now discuss some advantages and disadvantages of paying off an auto loan early.

Pros and Cons of Paying Off a Car Loan Early

If you can afford it, paying off your debt early has its benefits.

Pros:

• You will take full ownership sooner: Your lender will remain your car owner until you complete your loan payment. So, if you pay off the loan early, you will immediately claim the car’s ownership.
• Your DTI ratio will improve: Paying off early can lower your debt-to-income ratio. This will qualify you for better and bigger credit in the future.

Cons:

• Your credit score might drop if you stop paying a loan. This can happen even if you pay off the debt early. It could also affect your credit mix.
• Prepayment penalty: Some lenders charge extra fees for paying off early. If your lender has a prepayment penalty, then you will make extra payments if you pay off the car loan early.

FAQs: Answering Common Questions on Car Loans and Credit Scores

Does Getting A Car Loan Increase Or Decrease Your Credit Score?

When you apply for an auto loan, the lender will do a hard inquiry on your credit. This may lower your credit score for a short time. But, this effect does not take long. Over time, you can improve your credit score by paying on time.

How Long Does A Car Loan Affect Your Credit Score?

Generally, a car loan will temporarily reduce your score after someone conducts a hard inquiry. No one has set a specific period or time frame for credit scores to improve.

Your score will improve when you consistently make your monthly payments on time. It could take a few months or even a year, but the fact is that it will improve.

Will Paying My Car Loan Off Boost My Credit Score Immediately?

If you pay off your car loan early, your credit score will temporarily decrease. But after some time, it may increase because your DTI ratio has reduced. Your interest rate, budget, and other factors will determine whether you should pay off your car loan early or not.

How Many Points Does A Car Loan Inquiry Affect Your Credit Score?

Here’s what you should know about car loan inquiries and credit scores. A car loan inquiry will lower your score by about 5 points, but only for a short time.

What Happens To My Credit Score If I Miss One Car Loan Payment?

Even if you miss just one car loan payment, you will negatively affect your credit score. So, try as much as possible not to miss a single payment.

Can Refinancing A Car Loan Improve My Credit Score?

Refinancing a car loan can temporarily reduce your credit score minimally. But, over time, it will help save you some money.

Conclusion

There you have it!  A car loan can impact your credit score. It can be good or bad based on how you handle your payments. If you are trying to improve your credit score with a car loan, the ball is in your court.

Your score will significantly improve if you regularly make on-time monthly payments and responsibly manage your car loans. This will also make it possible for you to qualify for more loans or credit. Follow the tips highlighted to help you keep up with your loan payments.

To be safer, we urge you to check your credit score regularly with us. We offer the report for free. You only need to fill in your personal information for a free credit score report. One of our brokers will be in touch within no time.