Can I Build My Credit While Financing My Car?
When thinking about buying a car, many drivers wonder about how this huge amount of debt will affect their credit rating. Can it really build credit, or does it have a negative effect? The answer is: both! However, the dip in your credit score is very brief, rapidly offset by years of prompt repayments.
Every time you pay your auto loan on time, your credit score improves. The information added to your credit history includes payment promptness, amounts owed, duration, new loans, and your credit mix. These boosts usually appear in your score at milestone consolidation dates, like every six or twelve months.
What Factors Influence My Credit Score?
There are at least five factors that affect your credit score, each of them carrying a different weight. In very general terms, they are:
- 35% of your credit score comes from your payment history. For lenders, this is the most important parameter in your credit score. After all, if you have a record as a bad payer, the chances of approving your loan application drop steeply;
- 30% of your credit score reflects your utilisation ratio, which compares your total credit limit (how much you can borrow) with your total outstanding balance (how much you owe). Ideally, you should never borrow more than 30% of your total credit limit each month, and should preferably stick to 20% or even less. This gives lenders confidence that you can keep up with your commitments, while not maxing out your credit margins;
- 15% of your credit score reflects the average length of your credit history. This is why you should always keep your credit cards open, whether you use them or not;
- 10% of your credit score consists of new credits. This means that the more you apply for loans, the lower your score, particularly within short timeframes. Each time a new credit account is opened, your score drops, because it shortens the duration of your credit history.10% of your credit score is split between two types of credit: instalment and revolving. With instalment credit – like auto financing, home mortgages, and student loans – you pay a fixed amount each month on a regular schedule over a set number of years. In contrast, revolving credit – like credit cards – is an open line of balances and payments that are constantly changing, with set payment dates and unlimited duration.
Does an Auto Loan Affect My Credit Score?
It does indeed, because vehicle financing is usually included in your report as an instalment account, indicating that you have agreed to pay the same amount each month over a pre-set length of time. If you don’t have an instalment loan (like a mortgage) on your credit report, then financing your wheels could read your profile by improving your credit mix.
However, when you’re looking for auto financing, your loan application often gets sent out to several lenders for quotes. Whenever any of them check your credit report, a new enquiry may be recorded in some systems. Once you sign your financing agreement and your auto loan becomes active, this state is also added to your report, and you might lose a few points. But you can soon make up for this dip. When you make your repayments on time each month, your credit report shows that your loan is either “paid as agreed” or “current”. Both are greatly beneficial to your status, as your payment history has the strongest effect on your total score. However, should you fall behind schedule by thirty days or more, not only will these late settlements harm your score, you’ll also be at risk of repossession.
Takeaway
Your credit profile should reflect a healthy mix of instalment credit (like a car loan) and revolving credit (like credit cards). However, you should avoid applying for credit cards and auto financing at the same time, as a surge of applications can raise red flags, indicating that you’re desperate for money, rather than simply trying to improve your credit score.
