How Does a Car Loan Impact My Credit?

January 20th, 2022 by

Public transportation has become a way of life for most city residents, but the convenience of owning a vehicle is an advantage that many people can’t forgo. Needless to say, that convenience comes at a high cost, and an auto loan is the only means to pay such a high initial cost for most Americans. 

Whether your credit is deficient or in good standing, you might be worried about how taking out an auto loan could impact your credit score. The reality is that all kinds of finance have the potential to impact your credit score, both negatively and positively, and at different stages of the financing process.  

At North Coast Auto Mall in Cleveland, Ohio, our finance team works closely with you to make the entire car-buying process a breeze. From negotiating the best bank rates to securing quick approvals, our finance experts help provide you with peace of mind every step of the way.

Are you worried about your credit score and how an auto loan might impact it? Read on to learn more about how your credit could be affected as you embark on your car buying journey.

What Is a Credit Score?

A person holding money next to a miniature car

Buying a car” licensed under CC BY 2.0 via Flickr by marcoverch

Three major companies, TransUnion, Experian, and Equifax, provide credit scores. Your credit score, which is a three-digit figure within the range of 300 and 850, gives lenders an idea of how risky it would be to provide you with a loan. A high score reflects your history of repaying your loans on time. Therefore, lenders are more likely to grant you a loan.

Ways Purchasing a Car Can Affect Your Credit Score

To understand the overall effect of an auto loan, it’s important first to understand what makes up a credit score. These five key factors help determine your credit score:

  • Payment history. It makes up 35% of your credit score and is essential to your credit score. Paying your bills on time is the best way to improve and maintain your credit score.
  • Credit utilization. It has a 30% share in your credit score and measures how much of your available credit you use. It would help if you had a steady balance in your loan accounts to obtain a high score.  
  • Length of credit history. It’s 15% of your credit score, and the longer you’ve established credit with timely payments, the better your credit score.
  • New credit. It has a total share of 10% of your credit score and includes the number of new open accounts and the number of hard inquiries creditors make when you apply for credit. Too many inquiries indicate intensified risk and can negatively affect your credit score.
  • Credit mix. It includes a share of 10% of your credit score. Creditors like to see that you can handle different kinds of credit such as auto loans, mortgages, installment loans, store accounts, and credit cards. 

An Auto Loan Can Help Your Credit If:

When you first acquire a car loan, you might notice a slight drop in your credit score since you’re obtaining new debt. However, any temporary impacts on your score will disappear over time. But the positive effects will last for the length of the loan, as long as you continue making timely payments. Here is how purchasing a vehicle can help your credit score:

  • You make timely payments. Since payment history is the most significant factor in your credit score, making your monthly auto payments in full and on time increases your credit score over the long haul.
  • Improves your credit mix. Creditors love to see a combination of different types of credit in your credit file. Consequently, adding installment credit in the form of a car loan could help raise your score.

An Auto Loan Can Hurt Your Credit If: 

On the flip side, there are some ways an auto loan could potentially hurt your credit score, including the following instances:

  • Missing payments. Failing to make your auto loan repayments or paying them after the due date could damage your credit score.
  • Submitting multiple applications.  Every time you apply for credit, the creditor will conduct a credit check which registers on your credit report as a hard inquiry. If you submit multiple auto loan applications at once, you could risk hurting your credit score.
  • Paying off your auto loan. Longer credit histories are more desirable to creditors because they allow them to assess your credit behavior over a long period. Therefore, it’s best not to pay off your auto loan because it will no longer be an active account on your credit report and will cause your credit score to drop. And if it’s your longest-held account, the length of your credit history will be cut short.

How to Improve Your Credit Score Before Applying for an Auto Loan

Depending on how much work you need to do, our finance experts say you can increase your credit score in 18 months, give or take. To start making improvements, you can do the following: 

  • Use your credit cards wisely, including paying off some debt to reduce your amount owed.
  • If you notice defaults or missed payments on your credit file, contact the creditor to find out if you can settle the balance.
  • If you don’t have any payment history, consider getting a secured credit card and putting a small monthly charge on it. Then, pay it off in full every month to establish a positive payment history.
  • Keep your credit utilization under 30%. Going beyond that tells creditors that you can’t control your spending and depend on credit too much.

If you’re looking for a used car and unsure about your credit score and how it’ll impact your car-buying experience, reach out to North Coast Auto Mall. Our finance department would be happy to sit down with you and go over your options. You can also complete the pre-approval process online to get started on your way to a  pre-owned ride. A low credit score doesn’t have to keep you from getting into the car of your dreams. Feel free to contact us if you have any questions.

Posted in Auto Finances