Car buying is an important life decision. However, it can also impact your credit score. Your decision on whether or not to use a car-loan for your next purchase will depend on a number of factors.
Getting a car loan can help you build or rebuild your credit history and improve your FICO Score. A car loan will also allow you to refinance other loans and your mortgage at a reduced interest rate.
How does an auto loan affect your credit?
Your credit score is based on many factors, including your payment history and the length of your credit history. Having a long credit history and on-time payments can increase your credit score.
One of the main things that your credit score looks at is your credit utilization ratio, or the amount of revolving debt you have relative to your total credit limits. Having too much revolving debt can lower your credit score, so it's important to keep your balances low and pay down your balances as soon as possible.
Another factor your credit score considers is your credit mix, which reflects the different types of credit you have. The goal is to have a healthy mix of installment debt, like a mortgage or auto loan, and revolving credit, like credit cards.
Applying for new revolving credits, such as new credit cards, can help improve your credit score. However, you do not need to apply for them all at once. It could send a bad message to lenders about your financial situation.
Your credit score is also affected by the length of your history of credit and the age your accounts. Financing a new car can cause your average account age to decrease slightly, which can have an adverse effect on your length-related scoring factors.
It can also negatively affect your amounts owed variable, which makes up 30% of your credit score. The total amount of debt you owe increases when you add a new installment to your credit report.
Most people will pay their auto loan off early. Paying off an auto loan early can affect your credit score negatively.
Maintaining your auto loan with timely payments can have a positive effect on the length-related score factors that account for 15% your credit rating. If you close an automobile loan, the average age of your account will decrease because it is no more considered active.
A new car loan will have a positive effect on your credit rating as it allows you to establish a good credit history. Remember that your credit score may not improve immediately after a car loan.