Prospective car buyers often find themselves asking, “what credit score do I need to buy this car?”
But once they’ve moved past that, the question then becomes, “How does financing my new car affect my existing credit score?”
Let’s explore the ways in which your credit could be affected as you complete your car buying journey.
WILL TAKING OUT A CAR LOAN AFFECT MY CREDIT SCORE?
It’s important to keep in mind that credit scores are affected by multiple factors that depend on your specific situation. An event that could raise someone else’s credit score might have no impact on yours, and vice versa.
That being said, the act of taking out the car loan will typically have a slight negative impact on your credit score, as you’ve just increased your credit utilization (the total amount of debt that you owe). Also, since you’ve just taken on this new loan, there’s no payment history behind it just yet.
But don’t worry—this slight drop can be remedied if you make your auto loan payments in a timely manner. This is important since your history of making payments on time is one of the top factors toward determining your credit score.
In addition, auto loans can also affect your score in other ways depending on the types of accounts already listed on your credit report.
For example, if your report didn’t already have an installment type account, adding one in the form of an auto loan could help bolster your current credit score.
Having a diverse credit portfolio can show lenders that you can be fiscally reliable in different situations, provided that you’ve made regular payments on all of them.
WILL PAYING OFF MY CAR LOAN IMPROVE MY CREDIT SCORE?
If you pay down the full balance of your car loan, your credit utilization will have gone down, meaning that your credit score may improve. So since making regular timely payments on your loans is good for your credit overall, you’ll help maintain and possibly improve your score if you did.
If you’re thinking about paying off your car loan early to raise your credit score—you may want to learn how the result may not be what you’d expect!
On the flip side, sometimes things don’t always go as planned and you may find yourself in a position where payments are difficult to make on time—in that case, it could be worthwhile to check if you’re eligible for a loan extension which could provide temporary financial relief.
As long as your loan agreement does not include any penalties for paying the loan off early, doing so could save you money by eliminating interest fees over the life of the loan.
If the payments have always been made on time, the account will still have a positive effect on your credit history, even after it’s paid off and closed.
Keeping your Car Loan Open Can Help Credit Scores
However, open positive accounts may have a greater impact on credit scores than closed accounts. Open accounts show how you are managing your credit currently, rather than just how you have managed it in the past.
If you are still in the process of trying to establish credit, it may be more beneficial to leave your car loan open a while longer, at least until you have had the opportunity to open another account or two.
For instance, if you don’t already have a credit card, consider applying for one before paying off the loan.
Installment loans have fixed loan amounts and set monthly payments, but with a credit card, you dictate how much you spend and how much you pay off each month.
Because of this, credit cards are considered especially good indicators of your ability to manage your credit and your debt. That does not mean you should go apply for a lot of credit cards. You only need one or two.
In any case, don’t be afraid to check your credit report regularly—doing so results in a soft inquiry that won’t hurt your credit at all.
You are entitled to one free credit report per year from each of the three nationwide credit reporting bureaus (TransUnion, Experian, and Equifax).
Understanding how credit scores work and the impacts buying a car will have on it will help you continue to improve your credit score.
I do hear people often claim that they’re credit cannot be run, meanwhile they are sitting at my desk shopping for a car.
If you are not taking out a loan to pay for the car that’s really great! Aside from that, you need your credit is never harmed in the making of finding your next car.