Credit Repair

How Does Getting an Auto Loan Affect Your Credit Score?

private party auto loan

Opening any type of loan, including an auto loan, will typically result in an immediate slight dip in your credit score. It’s important to understand why your score drops if you get a new car loan and know that there’s no reason to panic. If you continue to make on-time payments and keep your overall credit utilization low, your score will slowly rise.

Negative changes to your credit score from an auto loan

There are two types of credit inquiries: soft inquiries and hard inquiries.

If you get an offer in the mail for 0% financing on a new car, that’s a soft inquiry. Soft inquiries do not affect your credit score.

But if you visit a dealer and decide to purchase a car, fill out the loan paperwork and give the dealer permission to run a credit check, that’s a hard inquiry. Hard inquiries will reduce your credit score by fewer than five points for about a year.

If your credit score is on the border between “good” and “excellent” (or “fair” and “bad”), those points could make a difference. You may not want to shop for a new car and a new home within the same year because multiple hard inquiries could drop your credit score and you could miss out on the best rates.

Fortunately, the credit bureaus understand that people may want to comparison shop for a car or home loan. If you have multiple inquiries of the same type within a 30-day timespan, the credit bureaus consider it a single inquiry.

Getting an auto loan will drop the average age of your account

The length of your credit history and the average age of your accounts make up 15% of your FICO score.

When you get a new auto loan, the average age of your accounts will fall slightly. If you have multiple accounts for decades, the hit will be very slight. But if you only have one or two accounts, it could have a bigger impact.

For instance, let’s say you’ve held two credit cards for 20 years, and three others for 18, 16, and 15 years. You also took out a mortgage 17 years ago. The average age of your accounts is 17.6 years. When you open a new car loan, that average will drop to about 15 years – still well over a decade.

But if you only have two credit cards that you opened a year ago, and you get an auto loan, the average length of your accounts drops in half, from one year to six months.

An auto loan will increase your credit utilization

While the age of your accounts makes up 15% of your credit score, your credit utilization ratio accounts for 30%, making it a significant factor in your total score. Your credit utilization should remain below 30% of your available credit; 20% is better.

When you open a new car loan, you will owe 100% of that loan, driving your credit utilization up. To minimize the negative impact, keep the rest of your balances as low as possible until you’ve paid down the car loan.

Positive changes to your credit score from an auto loan

Fortunately, any negative changes to your credit score will vanish as time passes. But the positive effects will last for the length of the loan, as long as you continue making on-time payments.

Lenders want to see that you can manage different types of credit responsibly when they consider giving you a new loan. There are three main types of accounts you can have:

  • Revolving
  • Installment
  • Open

 

Revolving accounts, like major credit cards, retail credit cards and gas station credit cards, as well as home equity lines of credit, allow you to borrow money up to a certain limit and make minimum monthly payments. Within this category, lenders want to see a variety of accounts, which is why you may want to carry one major credit card and a card from a favorite retailer.

Installment loans, including mortgages, car loans and personal loans, are paid off in equal installments over time. Unlike revolving credit, you no longer have access to that credit as the loan is paid down.

Finally, open accounts are lines of credit with no limit, which must be paid off at the end of every month, such as American Express charge cards.

Adding an auto loan can help improve your credit mix, provided you make on-time payments and manage the loan responsibly.

Tips for shopping for an auto loan

If you’re ready to make the leap and join the 44% of Americans with an auto loan, follow these steps to find the best interest rates:

Prep your credit

Buying a new vehicle can take time. As you start researching your dream vehicle, it’s time to also make sure your credit is in tip-top shape.

First, get copies of your credit report from all three major U.S. credit bureaus: Equifax, Experian and TransUnion. If you find any mistakes on the report, contact the bureau that provided it and file a dispute.

Don’t apply for any other new credit in the days and weeks before you apply for a car loan. You don’t want to risk lowering your credit score because it could mean paying higher interest rates.

Consider third-party financing

If you are buying a new or certified pre-owned vehicle from a dealer, it may be tempting to obtain an auto loan through the car dealer. After all, dealers entice you to apply for financing immediately with promises that you can “sign and drive,” without additional trips to a bank or more paperwork to file.

But unless you have excellent credit and qualify for 0% financing through the dealer, it’s wise to explore your auto loan options.

Smart borrowers will instead look at banks or credit unions to get financing. Banks reported $368 billion in open car loans in 2017, ahead of credit unions ($313 billion), and dealers, otherwise known as “captive auto companies” ($259 billion).

Know how much you can afford

While you want to negotiate with the car dealer based on the sticker price of the vehicle, it’s important to know your monthly budget before you apply for an auto loan.

Factors like the interest rate you qualify for, the length of the loan, your down payment and even the amount you’ll get for trading in your older vehicle can all affect your monthly payment.

Our auto loan calculator can help you determine how much you’ll pay out of pocket and your monthly payments before you apply for an auto loan so you’ll know what to expect.

Make your auto loan payments and watch your score rise

In sum, don’t be upset if your FICO score takes a hit after you close on your auto loan. Make your payments on time every month and you could see your score reach new heights. In the meantime, enjoy your new ride.

 

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