Back in the day, people used to ride a horse and carriages to get around. Luckily, we live in a day and age where we can use cars to get to where we need to go. However, even though cars are much more convenient, we have to deal with things like gas prices, car insurance premiums, car loans, etc.
Sadly, some of these factors can impact your credit score. Your credit score is an important part of life. That means that when dealing with your car expenses, you don’t want to accidentally ruin your credit score in the process. This begs the question…how much does a car loan affect your credit score?
Beyond the simple hard inquiry element (which we’ll discuss later on), the inability to pay back your auto loan in a timely manner can wreak havoc on your credit history. As a result, these types of loans may not be right for everyone – despite how attractive they are. We know you want that car – but if you can’t afford it, you risk needing credit repair down the road.
We’ll cover this and more throughout today’s discussion. First – let’s provide a brief overview of what an auto loan is in the first place.
Understanding the Auto Loan
Cars can be expensive, regardless of whether or not it is a used car or a new car. The average cost of buying a used car was $30,620 back in December 2021. That’s a lot but still less than the average price of a new car which was roughly $47,077 back in December 2021. Most people can’t handle these costs upfront. That is where auto loans come in.
When you need financing assistance, you can get an auto loan from a lender. This is when you borrow money (that you need to repay) from the lender in order to purchase the car. Since these are funds that you need to repay, you will need to enter an agreement with the lender and the seller to go over the terms of the purchase.
How to Get an Auto Loan
If you want to get a car loan it may be a more in-depth process than you realize. First of all, you will want to find the right lender. You can get financing support through:
- Financial Institutions
- Car Dealers
- Online Lenders
However, oftentimes people will go to the car dealership and see if they can finance through the dealer or a local financial institution that the dealership works with. Regardless, you have options to choose from. Each lender will have its own customer benefits, criteria, etc. One factor that they look at is your credit score.
Understanding Your Credit Score
Now that you have a better understanding of what an auto loan is, we’re going to move on to the next overview we need to provide to set the stage for today’s discussion: credit scores.
Your credit score is a number that’s generally between 300 and 850. This number is what lenders use to calculate your creditworthiness. Your creditworthiness is the measurement of how you handle the credit you borrow. This score is calculated by credit bureaus that use the information found on your credit report. Your credit report contains information about your credit file like credit accounts, on-time payments, credit history, etc.
There are three major credit bureaus which are Experian. Equifax, and Transunion. When credit bureaus calculate your credit score, they use a scoring model. There are two main types of scoring models which are either the VantageScore model or the FICO scoring model. While both are used, the FICO model is much more popular!
What Factors Impact Your Credit Score?
There are a variety of factors that impact your credit score. Since the FICO scoring model is more common amongst lenders, that is the model we will be using as a reference for how each factor can affect your score. The 5 factors are
Since your credit score is a number that lenders use as a way to understand how you handle the credit you borrow, it should come as no surprise that this is the biggest factor on this list. Your payment history includes information like on-time payments, late payments, and more. This factor accounts for 35% of your credit score.
Many people aren’t familiar with what credit utilization is but it’s an easier concept than you may think! Credit utilization refers to the ratio that looks at your overall credit limit compared to your current credit usage. For example, if you have a total credit limit between 2 credit cards that totals $2,400 but are using $1,848 then your credit utilization ratio would be 77%. This factor impacts 30% of your score.
Length of Credit History
The third factor on this list is your length of credit history. This factor accounts for 15% of your credit score. It includes information like the age of your accounts. This means it doesn’t matter whether it be the newest, oldest, average age of your credit accounts, etc.
People may not know that there are two types of inquiries that are important when it comes down to dealing with their credit score. There are soft inquiries and hard inquiries. Soft inquiries do not have any impact on your credit score (whether good or bad). However, hard inquiries are a different story. Hard inquiries (also known as hard pulls) allow lenders to get an in-depth look at your credit file. In order to get access to your credit file, you would need to provide written authorization. Hard inquiries can impact your credit by 10% (or up to 5 points).
At the end of this list is your credit mix. Just like hard inquiries, your credit mix accounts for 10% of your credit score. There are two main types of credit:
- Installment Loans
- Revolving Credit
Installment loans are loans that individuals repay like a new car loan, a mortgage, etc. On the other hand, an example of revolving credit would be a credit card or line of credit. The types of credit accounts you have on your credit report can impact your credit score!
Now – with all this said, let’s take a look at the main question you came here with today: how much does a car loan affect your credit score?
How Much Does a Car Loan Affect Your Credit Score?
Your credit score may go down a little bit when you take out a car loan, but it will rebound over time. In fact, your credit score will go up as a result of paying back your car loan in a timely manner. Here’s why:
Your credit score is a measure of how likely you are to repay debt. When you take out a car loan, you’re demonstrating that you can handle borrowing money and repaying it on time. This makes you a less risky borrower and can help boost your credit score. However, this is only true if you actually make your payments on time – and in the full amount. If you have late payments, it will lower your car. The same is true if you don’t make payments at all.
This is part of the problem with auto loans. Borrowers see them as an easy route to getting their dream car – even if they may not have the means of keeping up with the monthly payments. As a result, their car is repossessed and their credit history is left in shambles – with late payments and collections left on the record. So, we highly encourage you to learn more about what you can afford monthly – and what it could mean for your credit score.
Now, getting back to the question at hand – how much does a car loan affect your credit score? You can expect a slight downtick as you’re going through the process to secure your loan. Why? Simple – the loan provider will submit a hard inquiry on your credit to make sure you’re a suitable candidate for an auto loan. And, as we discussed earlier, hard inquiries can affect your credit score.
Commonly Asked Questions About Car Loans & Your Credit Score
Managing your car loan while handling your credit can be confusing. Luckily, it doesn’t have to be. People have had questions when dealing with their car loans and credit that you may have to. Hopefully, we can provide some useful information!
What’s the Minimum Credit Score Needed for a Car Loan?
The answer varies based on the lender. Not every lender will have the same eligibility guidelines. You may be able to get a pre-approval which involves a soft inquiry. This can give lenders a ballpark guess on whether or not you would qualify.
Is There a Way to Get a Car Without an Auto Loan?
The only way that you would be able to buy a car without an auto loan is by using other means of payment like cash or a credit card. However, these options are typically hard to achieve. Most people don’t have the cash they need upfront or the available credit to put the car purchase on their credit card.
Of course, an obvious solution is to simply pay for the car in cash. To do this, you can explore some of the ways to make extra money on the weekends we’ve offered in our complete guide. Or, take a look at some of the best side hustles for introverts. There are many ways to stop drowning in debt and start making more money – so you can live the lifestyle you’ve always wanted, and get your dream car!
Will Your Auto Loan Show Up on Your Credit Report?
Yes! Since an auto loan is a type of installment loan, you can expect this item on your credit report. That is why it is especially important to properly manage this type of account. Late payments will end up on your credit report and can stay there for up to 7 years! We recently wrote an article discussing whether or not credit repair companies can remove late payments – this is another great resource if you’re struggling to keep up with monthly installments.
Final Thoughts on How Much a Car Loan Affects Your Credit Score
So, how much does a car loan affect your credit score? In summary, your auto loan can affect your credit score in more ways than you realize. That is why it is important to have a clear understanding of what your score is, and what auto loans are.
While your score may drop momentarily as a result of hard inquiries, it should rise over time as you display good payment history. For many people, a car payment is their first real form of debt – so this is a great idea. But – only if you’re able to make your payments on time, consistently! Otherwise, an auto loan could wreak havoc on your credit history over time.
Only take this liability on if you can afford it month after month, for years and years. Remember – the last thing you want o do is end up needing to look into credit repair vs credit counseling, or seeking the help of a credit repair company to remove collections! If you want to learn more about this process, take a look at our article discussing what to bring to the dealership when buying a car!