A car loan by itself won’t always build credit. But, if you keep up with your monthly payments, an auto loan can definitely help you improve your credit over time.
How Do Car Payments Build Credit?
Taking out a car loan and making monthly payments on time and in full can help to improve your credit score. The reason why is because of the five components of a FICO score:
- Payment history (35 percent) – How frequently do you pay on time?
- Amounts owed (30 percent) – How much debt do you currently carry?
- Length of credit history (15 percent) – How long have your credit accounts been open?
- New credit (10 percent) – What new credit lines have you recently opened up
- Credit mix (10 percent) – What types of credit accounts do you have (i.e. installment loans, revolving credit cards)?
Out of the five factors, a car loan influences your payment history, new credit, and credit mix the most. Each on-time payment you make can improve your credit score over time, and because you’re taking on a new type of credit with an auto loan, your credit mix improves. Overall, adding a car loan can really improve your credit score and credit history.
Credit Impacts Over the Life of Your Car Loan
Just how your credit is affected by a car loan depends on how you handle it. Let’s look at four of the biggest impacts an auto loan has:
- Taking out a Car Loan – Your credit score is going to drop slightly when you take out an auto loan initially because you’re taking on new debt and adding a hard inquiry. It isn’t something to be concerned about, though, because you can build your credit back up over time. There’s no telling how many points your credit score could go up when you take out a car loan, but they definitely can help more than hurt you if you keep up with it.
- Making on-time Payments – Lenders look at your FICO score in order to determine what you qualify for, and the biggest impact on your credit score is payment history. If you’re consistent and pay all your bills (including your car payment) on time, our credit score should improve. In a few years time, this may even allow you to refinance your car loan to get a better interest rate.
- Late Payments – According to FICO data, a 30-day late car payment could drop your credit score as much as 90 points – even if you never missed a payment in the past. It all depends on how recent the issue is, how late the payment was, and your past payment history. But, it’s best if you can avoid missing a payment. If you don’t think you can make the next payment, reach out to your lender to discuss any options you may have.
- After the Vehicle is Paid Off – Once you pay off the car loan, you should see an increase in your credit score because the loan’s been closed and marked “paid in full.” According to Experian, once you’ve paid off a line of credit you may first see a slight drop in scores due to a major change in your credit history. But the drop is usually small and will likely come back “after a month or two” with the positive payment history of your loan remaining on your credit reports for 10 years.
Ready to Get a Car Loan?
When you have bad credit, you may find it tough to find a lender willing to work with you. If you weren’t able to get pre-approved by your bank or credit union, and aren’t sure where to find a subprime lender, let The Car Connection help.
We work with a nationwide network of dealerships that have the subprime lenders ready to work with car buyers struggling with credit. Get the process started today by filling out our free auto loan request form, and we’ll get right to work connecting you to a local dealer.