How Does a Car Loan Affect My Credit?

April 15th, 2022 by

Like any activity on your credit report, taking on a car loan affects your credit score, but there are ways to make the most of the new credit account. Having an affordable and current loan will help you maintain and build your credit history. Taking on new debt can lower your score temporarily, but with time, the new debt will be offset by positive payment history and a diversified debt portfolio. A car loan can affect your credit in several ways.

What Makes Up a Credit Report and Score?

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Credit reports and the credit scores tied to them are made up of several factors, including on-time payments, oldest credit line, percentage of available credit used, recent inquiries, new accounts, and amount of available credit. These factors have various weights when determining your credit score. Since this formula is complex, many credit card companies and other creditors offer free credit report checks and simulators that allow you to test the effect of positive and negative actions, like keeping a long-term account current or missing some payments.

Although the scoring models for different credit reporting agencies vary, the most common factors, and the percentages they contribute to your credit score, are:

  • Payment history makes up 35% of your credit score, with missed payments negatively impacting your score.
  • Credit usage, especially the percentage of credit used for revolving accounts like credit cards, makes up 30% of your score, so credit card balances that exceed 30% of the credit limit have a negative effect.
  • Credit history length comprises 15% of your credit score, including your oldest account and average account age.
  • Credit mix makes up 10% of your score, and this factor is improved with diversity, including credit types like credit cards, student loans, car loans, and mortgages.
  • New credit accounts and inquiries make up the remaining 10% of your credit score.

Applying for a Car Loan

The first step in getting a car loan is to apply, which you should consider carefully since it can affect your credit score. Credit applications show up in your credit report, so it’s best to limit how often you fill out an application that results in a hard credit report pull. Hard inquiries can reduce your credit score by five or 10 points for up to a year and are commonly on your report for two years. The average number of inquiries is three to five in two years, with fewer inquiries being better for your credit report.

If you’re shopping around for the best deal on a car loan, multiple credit reports pull for the same type of loan in a short period, most commonly 14 days, may show up as one inquiry. Having too many credit inquiries could indicate being financially over-extended. Your best bet is to only apply for credit when necessary and submit applications for a specific type of loan within that 14-day window. Not all queries affect your credit score. Soft inquiries, like lenders reviewing a credit report for screening or marketing purposes or checking your own report, aren’t visible to prospective lenders.

New Car Loans Shorten Credit History

Like any new account, new car loans shorten the average age of your credit accounts. The effect of a new car loan is minor for people with several long-term credit accounts, but it will have more impact on those who have a shorter credit history or a small number of accounts. Keeping some credit cards in good standing, ideally with balances of less than 30% of the credit limit, will help build your credit history. Other credit, like mortgages and student loans, are also factored into credit history. Credit reports often note the age of your oldest account.

Car Loans Don’t Affect Credit Utilization

Since car loans are fixed loans and not revolving credit like credit cards or lines of credit, taking on a car loan won’t impact the credit utilization portion of your credit score. Keeping this portion of your credit in solid shape is your best bet, keeping credit card balances under 30% of the credit limit.

How Car Loans Can Be Helpful

While new accounts and credit inquiries can temporarily lower your credit score, keeping a car loan current can improve several aspects of your credit report over time. Car loans diversify your credit mix, showing your ability to maintain various credit accounts. Installment loans, like car loans, are paid off according to a schedule, closing the account after the final payment. The loans stay on your credit history after they are paid off.

Check Your Report and Prepare for a Car Loan

Once you’ve found a vehicle or determined your budget for buying one, it’s time to begin the loan application process. There are a few critical steps in finding the best rates, including:

  • Check your credit report to make sure it’s accurate and address any negative or inaccurate entries. Three main credit bureaus collect and maintain credit history and personal information and offer free reports once a year.
  • Make sure your anticipated car payment fits into your monthly budget.
  • Look into the details and fine print when reviewing loan options and filling out applications to select the best lender and vehicle to meet your needs.

While taking on more credit may seem like a negative factor for your credit report, it’s easy to take steps to limit any adverse effects and make them temporary. If you intend to apply for different loan options through various lenders, submit all your applications within a 14-day window, so they show up as one inquiry on your credit report. A car loan will add to the diversity of your credit and won’t count against your credit utilization percentage since it’s an installment loan. Keeping a car loan current adds to your positive credit history.

When you’re ready to start shopping for a new or used vehicle, stop by Boch Toyota in Norwood, Massachusetts. We have a great selection of vehicles and can help connect you with financing options that will work with your credit and provide you with affordable payments. Give us a call at 866-633-0556, stop by to see us at 277 Providence Highway, or fill out our convenient online form and a team member will get back to you.

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