If you’re like the millions of Americans who have an outstanding auto loan, you may be wondering how your car loan affects your credit. Applying for and having a car loan does affect your credit, as long as the loan is reported to one of the major credit bureaus.
Like with most other debt obligations, responsibly making on-time payments can help your credit score — in this, way financing a car can build credit. On the other hand, making late or missed payments can hurt your credit score, as can the hard pull of your credit report that potential lenders conduct when you apply for an auto loan.
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How Does Car Financing Work?
While it is possible to pay for a new car with cash, it’s common for many potential auto buyers to use car financing. You may get a car loan for the full purchase price, or make a down payment and get a loan for the rest of the amount.
The lengths of car loans vary but are commonly 48, 60, or 72 months. After making your payments for the balance of the loan, the loan is paid off and you take full ownership of the car.
Note that your car acts as collateral for an auto loan. This means that if you fail to repay the amount borrowed, the lender can take your car to recoup its losses.
How Financing a Car Can Affect Credit Positively
Most car loans are reported to the major credit bureaus, and your payment history and balance is usually included on your credit report. Making on-time payments on your car loan can have a positive impact on your credit. Potential lenders want to see a history of reliably paying your debts, and making payments on a car loan can help with establishing that.
Another factor that makes up your credit score is having a healthy mix of different types of credit. This can be another reason why having an active auto loan can help build credit, as it adds to the types of credit you have.
How Financing a Car Can Affect Credit Negatively
Just as making on-time payments on your car loan can have a positive impact on your credit score, missed or late payments can affect your credit negatively.
Additionally, when you initially apply for an auto loan, the lender will conduct a hard pull on your credit report to verify your creditworthiness. This can drop your credit score by a few points, though those drops usually only last a few months. If you’re working with multiple lenders, keep in mind that hard credit pulls by multiple lenders in a short period of time will usually get combined.
And while paying down debt is often a good idea, paying off a car loan affects your credit in some additional ways. If you don’t have other debts or loans, it’s possible that paying off your loan can have a negative impact on your credit score. This is because your on-time payments no longer get reported, and you’ll have one fewer type of credit to your mix. Additionally, if you took out your car loan a while ago, paying it off can impact the average age of your open accounts, which also influences credit.
Factors That Influence Your Credit Score
The biggest factor that influences your credit score is your payment history. Potential lenders want to see that you reliably pay your debts, and making on-time payments is one way to show that. Other factors that influence your credit score are:
• Your average age of accounts
• Credit mix
• How much you owe
• How many recent inquiries appear on your credit report
Tips to Build Your Credit Score
If you’re wondering, ‘does a car payment build credit?’, then you’re likely hoping to boost your score. Here are some tips to consider to build credit:
• Make sure that you always pay your bills on time.
• As you apply for new debt or credit, only apply for loans that you know you have the financial ability and discipline to pay.
• Aim to keep your credit utilization — the amount of your total credit you’re using — at 30% or lower. Having a higher credit utilization rate can negatively affect credit.
• Remember to check your credit report at least once a year. Not only can this help you to monitor your credit health and understand the impacts of various activities on your credit, it can help you spot any errors or fraudulent activity.
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Mistakes to Avoid When Financing a Car
One of the biggest mistakes that you can make when financing a car is applying for a higher loan amount than you can afford. When you take out a car loan, you’re making a multi-year commitment to make those monthly payments. If you take out a loan for more money than you can reasonably afford, you run the risk of destabilizing your overall financial situation and ending up in a situation where you make late payments or, even worse, miss payments.
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Is a Car Loan a Wise Option to Build Credit?
A car loan can be a good option to build up your credit. Remember, what potential lenders are looking for when they look at your credit report is a history of meeting your debt repayment obligations. A car loan that you regularly pay on-time can be a great way of showing that you are reliable.
Follow our tips for getting a car loan to give you a head start toward building your credit.
Other Ways to Build Credit
Aside from turning to car financing to build credit, here are a few other ways to build credit that you might consider.
Become an Authorized User
Another way that you can build credit is by becoming an authorized user on someone else’s credit card account. When you are an authorized user on a credit card account, you’re not financially responsible for paying the statement, but it still shows up on your credit report. Keep in mind that how the primary account holder manages their account can affect your credit score, either positively or negatively.
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Consider a Personal Loan
Another option to build credit is by taking out a personal loan. Unlike a car loan, which is considered a secured loan since the car itself acts as collateral for the lender, a personal loan is an unsecured loan. That means that there is no collateral for the lender to seize if you stop making payments.
In certain situations, this can make a personal loan a great option for building credit. In fact, if an auto loan isn’t the right option, you can consider getting a personal loan for a car.
Apply for a Credit Card
Responsibly using a credit card and paying it off in full each month is another way that you can establish credit. Your credit card balance and payment history are typically reported to the major credit bureaus.
Additionally, some credit cards, like the SoFi Credit Card, offer rewards, such as cash-back rewards, with each purchase. Those rewards can be a boost to your monthly budget.
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The Takeaway
If you take out an auto loan to buy a new or used car, it will typically get reported to the major credit bureaus. That means making on-time payments on your auto loan can help you build credit. Similarly, late or missed payments can have a negative impact on your credit score.
Applying for a credit card and making regular payments can be another way to build your credit. When you’re ready for a new credit card, consider a cash-back rewards credit card like SoFi’s credit card. With the SoFi credit card, you can earn unlimited cash-back rewards if you’re approved. You can use those rewards as a statement credit, invest them in fractional shares, or put them toward other financial goals you might have, like paying down eligible SoFi debt.
Apply for a SoFi credit card today!
FAQ
Does paying off a car loan help build credit?
While making regular payments on your car loan helps you build credit, paying off your car loan doesn’t always have the same impact. When you pay off your car loan, you no longer have the monthly payment history showing up on your credit report. Still, paying off a car loan can be a good financial move since it helps lower the total amount of your debt.
How can I keep my payment within my budget when financing a car?
The monthly payment amount of your car loan will depend on a variety of factors — the total purchase price of the car, your down payment, the length of the car loan and your interest rate. If you want to keep your monthly payment below the average payment for a car, you can get a cheaper car, make a higher down payment, or take out a longer loan. You can also work on raising your credit score to hopefully qualify for a lower interest rate.
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How fast can a car loan raise my credit score?
While taking out a car loan can possibly build your credit, you shouldn’t count on an immediate positive impact. In the short-term, it’s possible that your credit score may decrease from the new credit inquiries and the additional debt that shows up on your credit report. However, over time, making regular and on-time payments on your auto loan could improve your credit score.
Does leasing a car build credit?
Most lease payments are reported to the major credit bureaus. That means that regular, on-time payments can help you build your credit in a similar manner to buying a car with a car loan. However, if you make late payments or miss payments on your lease, it can have a negative impact on your credit score.
Photo credit: iStock/Zorica Nastasic
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