Wondering how you can raise your credit score?
A car loan is a great way to help improve your credit score. When you borrow money and make regular payments on time, it shows that you’re responsible with debt. This will reflect positively on your credit report and could lead to an increase in your credit score.
Raising your credit score can be helpful for a number of reasons – from qualifying for a mortgage to getting the best interest rate on a car loan. If you’re looking to improve your credit rating, a car loan is one of the quickest and easiest ways to do it.
This article teaches the factors that impact your credit score and how fast a car loan will raise your credit score.
Factors That Impact Your Credit Score
To know if an auto loan will impact your FICO credit score (FICO score), it’s important to know what factors contribute to your credit score.
The three main credit reporting bureaus (TransUnion, Equifax, and Experian) assign a numerical value to each factor and add up your individual scores to determine your final score.
Each major credit bureaus use the following factors in determining your credit score:
Payment History
This factor makes up 35% of your credit score. When you make a regular payment on time every month, it shows that you have the ability to handle debt responsibly.
Car loans are no exception to this rule. If you’ve missed payments in the past, paying off the car loan on time will show lenders that you are capable of managing your money.
Amounts Owed
This factor accounts for 30% of your credit score. When opening a car loan, it’s important that you do not take on more debt than necessary because it could show lenders that you may have difficulty responsibly managing your money.
The general rule is to keep your total credit cards balance and loan balances less than 30% of your total credit limits. Having a low balance on your amount owed is always a good idea.
Credit History
The length of credit history factor makes up 15% of your credit score. It shows how long you’ve maintained a particular credit account or loan and the frequency of late payments on those accounts. These accounts could range from student loans, personal loans, mortgages or any other outstanding debt. Keeping good credit history is crucial to raising your score, so it’s essential to develop good money management habits early on in life.
By paying a car loan on time consistently, you will demonstrate a long credit history and good payment habits, which will positively impact your credit score.
New Credit
This factor counts for 10% of your credit score. Don’t open too many lines of credit at once because it can show lenders that you may be entering into financial trouble. It is best to only open one new account, like a car loan, at any time.
Opening new credit accounts, like a car loan, will result in a hard inquiry on your credit report. This essential factor accounts for 10% of your credit score.
Credit Mix
This factor makes up 10% of your credit score. It shows whether you’re using different types of credit (such as revolving, installment, and mortgage).
A car loan that reports to all three major bureaus helps diversify your credit mix by demonstrating that you can responsibly handle different types of debt.
Car Payments Build Credit History
A car loan is a great way to build credit history. If you pay the monthly payments on time every month, it’s reported as timely payments and can be viewed as proof that you can responsibly manage your debt.
If you already have a good credit score, a car loan may not cause an immediate increase in your credit score. That said, if you can refinance or sell your car before making another payment on it, you may not experience an increase in your credit score.
If you are looking for a quick way to raise your credit score, a new loan for a car is one of the fastest ways.
Being responsible with your credit is important for planning for the future, but it can also impact other aspects of life.
For example, by paying off a car loan on time, you may be able to qualify for early mortgage approvals if that’s something you are interested in doing. You can also raise your insurance rates or receive better interest rates while renting an apartment.
How a Car Loan Can Help Improve Your Credit Score
When you buy a car, your credit score takes a hit. Though the impact is temporary due to the hard inquiries and will eventually lead back up again in the long run with monthly payments on time, most people experience this reduction first.
As you pay off your car loan on time, you demonstrate that you are responsible with debt, and will show on your credit report. In addition, the more high-quality accounts that are reported to your credit history, the better it is for your overall credit score.
A recent study by the Federal Reserve found that auto loans are the most common type of loan used to build credit.
Here are some additional benefits of taking on a car loan:
- A car loan will help you establish good payment history on your credit report. However, keep in mind that it will take up to 30 days from your payment due date for your creditor to report your payment to the bureaus.
- A car loan will help you establish a lengthy credit history on your credit report. The more years of on-time payments that are reported back to the bureaus, the better it is for your credit score.
- If you have bad or no credit history, having a car loan (and paying it off on time every month) will help you establish good payment history and prove to lenders that you can handle different types of debt.
- A car loan is relatively small and affordable, making repayment more manageable. Additionally, because installment loans are reported to the credit bureaus monthly instead of quarterly like mortgages, it will show up on your credit report faster than other types of loans.
- Having multiple types of loans (such as a car and a house) can help diversify your credit mix.
How a Car Loan Can Hurt Your Credit Score
You need to be careful about how you handle your car loan. If you stop paying your monthly payments, then it will have. negative impact your credit score even more than it would if you had no debt at all! The key is to pay off the loan on time every month (and pay for any damage you make to the car) and stay in good standing.
Having any late or missed payments on your credit history is detrimental and can cause your score to drop hundreds of points. In addition, it can take several years to repair a bad credit history where you had some missed payments, so be careful!
It’s also important not to stretch yourself too thin with debt. If you constantly take on new loans, especially those beyond your ability to pay back, you will quickly find yourself in a bad financial situation, and your credit score (and life) will suffer as well.
Things to Look For When Getting a New Car Loan
While you are looking for a car loan, be sure to get quotes from various lenders to know what your options are and verify that the rates and terms are competitive.
You should also be aware of any prepayment penalties for paying off your car loan early, especially if you want to pay off the whole thing before the 3-5 year term is up! If there is a hefty penalty, it’s not worth it to pay off the loan early.
Other things to look for include:
- Lower Interest rate for car loans. Search for the best rate possible and avoid higher interest rates as this may end up costing more than you can afford.
- Longer loan term (3 years or longer). Auto lenders can provide you options depending on your situation.
- Lower down payment amounts
Wrapping It Up
Car loans are a great way to build credit and establish a good payment history. If you’re looking for a quick way to improve your credit score, this is definitely one of the fastest ways.
As you pay off your car loan on time, you demonstrate that you are responsible with debt, and will show on your credit report. This will prove valuable when you are in the market to purchase more considerable debt, such as a home.
Getting a car loan is relatively small and affordable, making repayment more manageable. Additionally, because installment loans are reported to the credit bureaus monthly instead of quarterly like mortgages, it will show up on your credit report faster than other types of loans.
Having multiple types of loans (such as a car and a house) can help diversify your credit mix, which is good for your overall credit score.
For many, purchasing a car is an essential need. If you are going to get a car loan, ensure you are making all your payments on time and getting a loan that you can afford. If you happen to miss a payment because you can’t afford the monthly payment, this will cause your credit score to go the other way.
