Car loans are handy financial tools perfect for buyers who prefer paying for their car purchase gradually. Rather than an upfront expense worth tens of thousands of dollars just to buy a car, financing gives people the chance to pay back the amount they owe over time.
However, since car loans mean you will borrow a hefty sum of money that you need to pay back in a span of several years, you might be wondering about its impact on your credit.
Continue reading to know how a car loan can increase your credit:
Will Getting a Car Loan Affect Your Credit Score?
Every time you shop around for the best rates for car financing, some lenders conduct a hard pull to your credit. Although these hard pulls do affect your score most of the time, one hard inquiry normally lowers your credit score by only a few points, which means there will be a small overall impact.
If your credit has several hard pulls from different lenders, take note that everything will be combined as one provided that they take place within a certain timeframe. This window is only often applicable to inquiries for loans of installment type like car loans and mortgages. In some cases, the range could reach up to 45 days depending on the specific credit bureau.
Will It Hurt Your Credit If You Take Out a Car Loan?
To understand the effect of car loans and how a car loan can increase your credit, you have to be familiar with a credit score’s anatomy. The following are the 5 main factors that FICO considers when calculating credit scores:
- Credit Mix
It can be a helpful plus if you are managing several types of credit like credit cards and an auto loan.
- Credit Utilization
Credit utilization measures the amount of available credit you are using. To determine the optimal utilization rate at the moment, you might want to check with TransUnion, Experian, or Equifax, the three major credit reporting bureaus in the country. Having high balances on various accounts may imply a higher chance of defaulting to lenders.
- Credit History’s Length
Generally speaking, you will have a better score if you have established your credit with timely payments for a longer time. However, FICO checks multiple indicators in relation to your credit history.
- New Credit
You can boost your credit utilization rate if you establish new credit and open accounts only as needed. For example, applying for several credit cards simultaneously may have negative effects on your credit score.
- Payment History
The most crucial aspect of your score is making timely payments.
Considering all these factors, getting a car loan may impact your credit score in different ways. For one, it will change your credit utilization ration and increase your overall debt load which might lead to a slight lowering of your score.
If you have recently established a loan, it doesn’t have a payment history just yet. However, any small decline in your credit score will be remedied right away if your first several payments are made on time. Once again, don’t forget that your payment history has the most impact on your FICO scores.
A car loan can also boost your credit mix, especially if your report doesn’t have any installment-type account yet. A diverse credit portfolio implies that you were successful in managing different types of credit that lenders find appealing.