Many borrowers can be hesitant to enter the world of credit. Taking on too much credit all at once is risky, but you have to start somewhere if you plan on making large purchases in the future. Your credit score is an integral part of your buying power, and financing a car is a good place to start.
Understanding Your Credit Score
Buying a vehicle with cash doesn’t improve your credit score, but taking on an auto loan and making all the payments on time does.
If you’ve never had any credit, you’re called a no credit borrower, and this usually leads to a lower credit score. If you’ve borrowed credit before but let some things slip, you may have bad credit.
Your credit score is almost always referenced when you apply for new credit, such as car loans or credit cards. With a low credit score, you could face a denial when you apply. Traditional auto lenders have credit score requirements, and not meeting just one qualification could be enough to get turned down for financing.
This is why it’s important to strive toward a better credit score. Not only does a good credit score mean a better chance of qualifying for credit, but it also means improving your chances of qualifying for a lower interest rate, which means saving money when you need to borrow.
Building a better credit score means attacking it with some strategy and understanding what it’s made of. The most commonly used credit scoring model is FICO.
There’s five aspects to the FICO credit scoring model:
- Payment history: 35%
- Amounts owed: 30%
- Length of credit history: 15%
- Credit mix: 10%
- New credit: 10%
To build a better payment history, you need to take on credit. Many borrowers start their credit history with a car loan, or use them to get back on their feet.
How Auto Loans Build Credit
Auto loans impact every aspect of your total credit score. Since car loans typically last around 48 to 96 months, there’s a potential for years of good credit building.
Each category of your FICO credit score carries a different weight, and auto loans hit each one:
- For the new credit aspect, when you get new credit, it lowers your credit score a little bit for 12 months. The FICO scoring model keeps track of how often you apply for new credit, and taking on or applying for lots of new credit in a short time can lower your credit score. But each hard inquiry’s damage is temporary, and doesn’t last very long.
- Payment history keeps track of your on-time, late, and missed payments. The more timely payments you have reported on your credit reports, the better your credit score. This is the biggest part of your credit score, so the best way to build credit is paying all of your bills on time.
- Paying off your car loan affects your amounts owed category as well. With each on-time payment, you’re lowering the amount you owe and building your payment history.
- As far as length of credit history, this is more passive. As time goes on and the longer an account is active, the better your credit score. If you have old accounts that you don’t use anymore, keep them open anyway because closing them can lower your credit score. The older something is on your credit reports, the better it reflects on your credit history.
- Credit mix refers to the different kinds of credit you’re actively using. If you only have credit cards, which is revolving credit, your credit mix isn’t too great. However, with a healthy mix of installment loans, like auto loans added to your mix, it tells the FICO scoring model that you can manage different kinds of credit.
Remember: the best way to build credit is by paying all of your bills on time, every time. One missed or late payment remains on your credit reports for up to seven years. If you do have missed or late payments on your credit reports, their impact lessens after each year but it takes a while before they completely fade.
Getting a Car Loan With Poor Credit
So, how do you start a credit history with a car loan when your credit score is poor? The answer lies in working with the right type of lender.
Subprime auto lenders specialize in assisting borrowers with unique credit, bad credit, and no credit. Instead of just using your credit score to determine your car loan eligibility, they look at the other aspects of your entire situation. This includes your work and residence history, overall income and debt to income, your down payment size, and more.
These lenders also report their loans to the credit bureaus, so even with poor credit, you can start to build a positive credit history with an auto loan.
Finding the Right Dealership
Starting a subprime car loan begins with finding a special finance dealership. Subprime lenders are third-party, and they’re signed up with these dealers. Not sure where to start looking? Then get with us at The Car Connection.
No need to drive all over town looking for a special finance dealership, because we’ve already created a nationwide network of dealers that are equipped to handle tough credit situations. Fill out our free auto loan request form, and get back on the road to better credit with a car loan.