Does a Car Loan Build Credit?
Consumers looking to purchase a new car often want to know how it’s going to effect their credit. Does a car loan build credit or does it cause it to drop?
Consumers looking to purchase a new car often want to know how it’s going to affect their credit. Does a car loan build credit or does it cause it to drop? Ultimately, a car loan does not build credit; however, you can use the car loan to help increase your score.
A car loan has two common effects on credit:
- It causes a hard inquiry to be added to your credit report, which could temporarily lower your credit score by a few points.
- It increases your credit history. Provided you don’t have any late or missed payments, this increase can help build your score.
Factors That Influence Your Credit Score
There are five factors that influence your credit score:
- Payment history.
- Utilization ratio.
- Length of credit history.
- New credit.
According to Wallace Automotive Group’s Financing Team, payment history is the most significant factor that affects your credit score. It makes up 35% of your total FICO score, which is what lenders use most often.
The utilization ratio counts toward 30% of your credit score. It’s used to compare your total outstanding balance to your total credit limit. Your outstanding balance is the amount of money that you owe while your total credit limit is the maximum amount of money you’re able to borrow. The goal is to borrow 20% or less of your total credit limit. For example, if your credit limit is $2,000, then you shouldn’t borrow more than $400 per month.
When it comes to length of credit history, older is better. This is why you should always keep credit cards open, whether you’re using them or not. When a new credit account is opened, like a car loan, it might lower your score because it decreases the average length of your history. The length of your credit history makes up 15% of your score.
New credit affects 10% of your score. The more you apply for loans, especially in a short timeframe, the lower your score drops.
There are two types of credit:
- Installment.
- Revolving.
Installment credit means that you pay a fixed, regularly scheduled amount each month. Examples of this type of credit include car loans, student loans, and mortgages. Revolving credit is an open line of credit with constantly changing balances and payments, for example, credit cards. Credit types make up 10% of your total score.
Auto Loans and Your Credit
The chance of an auto loan affecting your credit report and your credit score is high. An auto loan is usually added to your report as an installment account, meaning you pay the same amount each month for a fixed amount of time. If you don’t have an installment loan on your credit report, then getting an auto loan could help your profile by creating a better credit mix.
If you pay your car payment on time every month, then your credit report will show that your auto loan is either “current” or “paid as agreed.” Due to the fact that your payment history has the greatest effect on your score, a “current” or “paid as agreed” status could greatly benefit your total score.
If you fall behind on your payments by 30 days or more, Wallace Automotive warns that not only will your credit score be damaged, but you’ll also be at risk of having your vehicle repossessed. If you’ve paid all of your auto loan payments on time but your credit report has an error showing that you made a late payment, you should look into filing a dispute.
Tips to Improve Your Credit Score
The quickest way to improve your credit report and score is by being a responsible buyer. This isn’t limited to only your monthly auto loan payment. If you pay the full amount of all of your bills on time every month, you will slowly improve a poor credit score. While there isn’t a quick fix to a bad score, being responsible with your payments will definitely help.
In addition to keeping up with your payments, Wallace Automotive Group recommends the following tips to improve your credit score:
- Keep your credit cards open.
- Have a healthy mix of credit types.
If you want to have a strong credit report, then you need a lengthy credit history. If you have a credit card that you opened years ago and never use, don’t close it. As long as it’s not maxed out, it will help improve your score by providing positive history. When lenders look at your current credit use, they like to see that you’re not using any more than 30% of your available credit. This gives them confidence that while you’re using your credit, you’re also keeping up with your payments.
You want your credit profile to have a healthy mix of installment credit, like auto loans and mortgages, and revolving credit, like credit cards. However, don’t apply for all of these at one time. A surge of credit applications will put up a red flag and make you appear desperate for money rather than simply looking to improve your credit.
Does a Car Loan Build Credit?
A car loan in and of itself does not build credit. In fact, Wallace Automotive Finance Department mentions that once you take on a car loan, your credit might actually experience an initial decrease. When you first apply for a loan, your application typically gets sent out to a few lenders. Whenever a lender reviews your credit report, a new inquiry will be added to your account. An inquiry is a record showing that someone has viewed your credit report.
Any inquiries that are made for an auto loan will appear on your report; however, most credit scoring systems will combine multiple inquiries so that they only count as one. Some of the newer credit scoring systems don’t count auto loan inquiries at all.
When you buy your vehicle and the auto loan becomes active, the debt will be added to your report. This is when you might lose a few points on your score. Once you prove that you can manage your new debt by making on-time payments, you should more than make up for those lost points.
If you plan on using a car loan to build credit, it’s important to understand that the loan itself will not help build your credit report or score. In fact, the loan will likely lower your credit score at first. However, if you establish a solid payment history by keeping up with your monthly payments, your auto loan should help to improve your credit score in the long run.
Wallace Automotive wants to help you buy a car and our experienced and friendly finance department will work with you and the banks to find the best loan that suits your budget and needs.
Contact us today to inquire about our current Lease and Finance programs that are available right now. Don’t forget to check out our Monthly New Vehicle Specials and Used Vehicle Specials for even bigger savings!
If you need an oil change, brakes, tires, or maybe have a check engine light on we recommend you stopping over at one of our Service Departments for a complimentary vehicle inspection. Browse our Monthly Service Specials for coupons and money saving deals also!
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