Drivers who are looking to get an auto loan often want to know how it’s going to affect their credit. So, does a car loan build credit or does it cause your score to drop?
By itself, a car loan does not build credit. However, you can use the car loan to help increase your score by making on-time payments.
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How Does a Car Loan Affect Credit?
The act of opening a car loan will impact your credit score. Initially, you might see your credit score drop slightly. That’s the effect of lenders performing a hard credit check, which allows them to calculate your interest rate and other loan terms.
Any credit inquiries that are made for an auto loan will appear on your report. However, most credit bureaus combine multiple inquiries so that they only count as one. Even if you apply for a few car loans within a short time frame, it shouldn’t affect your score significantly.
Once you start making loan payments, your credit score should rebound. And by keeping up with your monthly loan payments, your credit score should increase in the long run.
However, having an auto loan can hurt your credit score if you aren’t consistent with your payments. If you’re more than a month late on a payment, or you’re consistently missing the due date, you can expect your credit score to drop. Plus, if you don’t communicate with your lender, you could be at risk of having your vehicle repossessed.
Factors That Influence Your Credit Score
Your credit score determines how “creditworthy” you are, which essentially shows how responsible of a borrower you will be. There are several factors that influence your credit score.
Payment History
Your payment history is one of the most significant factors that affects your credit score. It makes up 35% of your total FICO score, which is what lenders use most often. Making on-time payments for loans and credit cards is important for this reason. If you fall behind on your payments, your credit score will drop.
Credit Utilization Ratio
Your credit utilization ratio counts toward 30% of your credit score. It’s used to compare your total outstanding debt to your total credit limit. Your outstanding debt is the amount of money that you owe, while your total credit limit is the maximum amount of money you’re able to 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’re using them or not. The length of your credit history makes up about 15% of your score.
New Accounts
New accounts affect 10% of your score. If you open multiple loans or credit cards over a short period of time, it could have a negative impact on your credit score. Be mindful 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. This isn’t limited to your monthly auto loan payment, either. If you pay your bills on-time every month, you will slowly improve your credit. While there isn’t a quick way to repair a bad score, being responsible with your payments will definitely help.
In addition to keeping up with 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, think about keeping it open. As long as it’s not maxed out, having an active account is a good way to establish a long credit history.
You also want to have a healthy mix of accounts, like auto loans and mortgages, and revolving credit, like credit cards. However, don’t apply for all these accounts at the same time. An influx of credit applications may raise a red flag to lenders and credit bureaus, which could have a negative impact on your score.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. She has extensive knowledge of various insurance lines, including car insurance and property insurance. Her byline has appeared in dozens of online finance publications, like The Balance, Investopedia, Reviews.com, Forbes, and Bankrate.
