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Buying a car delivers plenty of thrills, but can it also help improve your credit? Auto loans can positively or negatively affect your credit, depending on whether you make your payments on time and repay the loan in full as agreed.
Experian's State of the Automotive Finance Market for the second quarter of 2023 reports that the average new car auto loan is $40,657 and $26,863 for used cars. And with car prices at all-time highs, most car buyers have little choice but to use financing. If you plan on buying a car with an auto loan, it could affect your credit positively or negatively depending on whether you make payments on time and repay the loan in full as agreed.
How Much Does Your Credit Score Drop After Buying a Car?
When you use an auto loan to buy a car, your credit score will likely take a slight hit due to the increase in your debt load and the hard inquiry that results when the lender checks your credit. Thankfully, the credit score should only dip a few points temporarily. Your credit should bounce back in short order as you make consistent on-time payments on your loan.
That being said, don't let concerns about hard inquiries keep you from rate shopping for the best auto loan. As long as all of your auto loan inquiries take place within 14 days, credit scoring models count them as one inquiry when determining your credit score. Newer FICO® Score☉ models extend the window to 45 days, but keeping your rate shopping period to within two weeks should minimize the impact of multiple hard inquiries.
Does Buying a Car Help Your Credit?
Whether buying a car negatively or positively impacts your credit will depend on how reliably you make your loan payments and your current blend of credit accounts. Here's how buying a car has the potential to positively affect your credit:
Add On-Time Payments to Your Credit History
Your payment history plays a significant role in your credit score, accounting for 35% of your FICO® Score. As such, making regular, on-time payments on your car loan may improve your credit standing over time. Setting up automated bill payments through your bank can be an excellent strategy for avoiding late payments and protecting your credit score.
Diversify Your Credit Mix
Adding an auto loan to your credit portfolio could have a positive effect on your credit. That's because credit scoring models also consider how well you manage different types of credit, including installment credit, like student loans and mortgages, and revolving credit, such as credit cards and lines of credit. Your credit mix accounts for 10% of your FICO® Score.
Does Buying a Car Hurt Your Credit?
When you apply for a car loan, the lender's hard inquiry into your credit could temporarily ding your credit score by a few points. However, its effect is usually short-lived, and you may strengthen your credit in the long run by making timely payments.
Still, how you manage your auto loan is critical, and some scenarios could harm your score.
You Miss Payments
Buying a car can hurt your credit if you're unable to make your monthly car payments. Keep in mind, the lender may consider your payment late if you miss your payment due date by even just one day. You'll usually have a short grace period during which you can make up the payment without penalty, however.
If a full billing cycle passes and you still haven't paid, the lender will report your delinquency to the major credit bureaus (Experian, TransUnion and Equifax). Even a single 30-day-late payment can severely harm your credit score and remain on your credit report for seven years.
You Default on the Loan
Some auto lenders will declare your loan in default 30 days after your payment is due; others will wait 90 days. Once your loan is in default, your account may be turned over to debt collectors, who will contact you to seek payment. If you still don't pay, your car could be repossessed, which could cause additional harm to your credit health.
Having a repossession on your credit report can make it much harder to secure credit with favorable terms for up to seven years (the length of time the repossession appears on your credit report). That's why it's so important to review your budget and long-term income stability to make sure you can afford the payments before taking on an auto loan.
You Can't Afford the Loan
If you're struggling to make your car payments, you might fall behind on other bills, leading to late payments that could negatively affect your credit score. Before you buy a car, review your budget to be sure you can manage the monthly payments and other costs of car ownership.
Additional Ways to Build a Positive Credit History
If your credit isn't where you want it to be, consider pausing your carbuying efforts and taking some time to improve it before applying for an auto loan. By doing so, you'll improve your odds of approval with a lower interest rate that could lower your interest charges and monthly payments.
Consider the following strategies to shore up your credit.
- Continue making all your bill payments on time. Your payment history is the most important factor making up your credit score, so it's essential you pay your bills on time. Even accounts that don't typically appear on your credit reports, like gym memberships and medical bills, can harm your credit if the payment is late. That's because any late or unpaid accounts that get sent to collections could trigger a dip in your credit scores.
- Pay down debt balances. Your credit utilization ratio—the amount of your revolving credit limit you're using—accounts for 30% of your FICO® Score. A common rule of thumb is to keep your credit utilization ratio below 30%, but the lower your ratio, the better. Many high credit score achievers have credit utilization ratios below 10%.
- Get a credit card. If you're new to credit, you can build a credit history by applying for credit cards, using them for small purchases each month, and paying your bill on time and in full. If you can't qualify for a regular credit card, consider applying for a secured credit card. These cards require an upfront deposit, making them easier to qualify for.
- Become an authorized user. One of the easiest ways to build credit is to "borrow" someone else's. You can do this by asking a close friend or relative with good credit to add you to their credit card account as an authorized user. When you do so, you automatically inherit their positive credit history with the card, which may help bolster your own credit.
- Get credit for rent payments. If you're a renter, you can ask your landlord to report your rent payments to credit bureaus. Most landlords don't normally do this, but if yours is willing to start, adding the information to your credit report can help build your credit. Alternatively, you can sign up for Experian Boost®ø, which gives you credit for bills you already pay, like your cellphone, utilities and even rent.
Pay Close Attention to Your Credit
It's critical to make your payments on time when you buy a car with an auto loan. Despite your best intentions, it's easy to let a due date slip through the cracks if you're juggling multiple bills. Help yourself out by adding your due date to your calendar or setting up automatic payments to help ensure you never miss a payment.
To see how your auto loan affects your credit score, consider signing up for free credit monitoring from Experian. You'll get monthly credit reports, notifications of activity on your credit report and alerts whenever your credit score changes. It's a great way to stay in the driver's seat when it comes to your credit.