Does Taking a Car Loan Affect Your Credit Score?

Getting a car loan can have a wide range of effects on your credit. As your debt load increases, your credit score may experience a minor drop. However, it will rise as you make timely loan repayments.

If you have a more pressing question on whether a car loan affects your credit score, this article is for you. Here, you’ll learn valuable insights on: 

  • How car loans affect credit scores
  • How to avoid a car loan credit drop
  • Other factors affecting credit score decline

How Car Loans Affect Your Credit Score

While applying for a car loan, lenders will pull up a hard inquiry of your credit report. This will temporarily lower the score between 5-10 points for a year. 

Once the car loan is approved, your credit score will drop because you have more debt. The good thing is this will quickly bounce back and remediate as you make your payments on time. 

Consistent, timely payments will help build higher credit scores. Payment history influences your FICO score the most, with 35%. FICO score is the model used by most lenders during car loan applications. 

Car loans will enhance your credit mix, which accounts for 10% of your FICO score. A healthy combination of credit cards (or other revolving credits) and installment credit (like car loans) in your credit history will assure auto lenders of your creditworthiness. It will show that you are successful in managing various credit accounts

When you only have a revolving credit card (like a credit card), you can add installment credit as an auto loan to improve credit score. It will help convince the auto lenders to approve your application. 

Getting a car loan with cashback will also benefit your credit score. You can use the money to pay a part of your credit card balance. It will give you less amount to pay off later on.  

Another way to lessen the amount to fill in the auto lender is to save for a downpayment. You will have lower interest rates when you pay a massive chunk of the original car loan amount at the beginning of your loan.

Other Factors that Affect Your Credit Score

Other factors affect your credit or FICO score besides payment history and credit mix. These include:

Amount Owed

This is the next most influential in your score, with 30%. The amount you owe is showcased through the credit utilization ratio. This ratio measures the available credit that you are using and gives you an overview of how non-cash funds reliant you are. You can calculate this by dividing the total revolving credit you currently use by the sum of all revolving credit limits. 

Keep this ratio low and spend within your means. Avoiding grace periods will also keep your debt decently low. This will save you from possible long-term financial pains and will not stretch your accountability to repay.

This is why planning before shopping for a car loan is good. You need to assess your assets and priorities. For instance, can you afford another loan on top of other loans?

Credit History

The length of credit history makes up 15% of your score. The longer your credit history is, the higher your credit scores will be. It consists of the average age of all your accounts, the age of your oldest credit account, and the age of your newest credit account. 

New Credit 

New credit holds 10% of your score, which refers to the number of newly opened credit accounts and some hard inquiries the lenders make. 

If you send credit applications to several auto lenders all at once, you will have too many hard inquiries that will hurt your credit score. Thus, it pays to be picky when choosing auto lenders. 

Minimum Credit Score for a Cash Loan

If you consider a cash loan an option, lenders or dealers tend to approve borrowers with 660 or higher credit scores, which implies lesser risk. 

Qualifications for a Car Loan

Let’s say you are ready to get a car loan. To be eligible, these are the basic requirements you should manifest; proof of residency (should be a resident of Canada), Canadian driver’s license, the age of majority in your territory or province, proof of income, proof of car insurance, consent to a credit rating check, and good credit score, 

The car loan standards vary between lenders, but those are the few basics you should prepare. 

Paying Car Loan Early

Early payment to your car loan will not hurt your credit score. However, not paying your car loan earlier than the deadline will also benefit you. 

It will help you improve your credit rating. Monthly payments will impact your credit score and rating more than a lump-sum payment.

Besides, you will have the chance to pay more essential debts before the car loan. 

Lastly, a pay-off penalty might hit and not miss. In this case, you should assess whether you would pay the penalty fee instead or wait until the monthly deadline. This way, you will see which option you can save money on. Reviewing the terms and conditions with the auto lender will be helpful.

Conclusion 

There you have it! Those are the essential things you should know about how a car loan affects your credit score. Rather than driving downhill, negatively affecting your credit score, aim for what will best serve you.

FAQs

What is the minimum credit score for a car loan?

A minimum credit score of 650 is usually needed to qualify for a car loan with fair interest rates. Higher interest rates may need lower credit scores. Generally, a good credit score ranges from 660 to 724.  

How much will a car loan raise my credit score?

A car loan on its own will not raise your credit score. However, a consistent on-time payment will help increase your credit score since payment history accounts for 35% of your credit score.

Sources:

Cameelle Suarez
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