If you want a brand new car, chances are that you don’t have the cash on hand to buy the vehicle outright, especially if you are going with a new vehicle. As such, you will need a car loan.
You may be wondering, however, how obtaining a car loan will affect your credit score. You have likely hears from friends, family and the friendly car salesman that getting a car loan will help boost your credit score. Let’s take a look at the facts:
The credit check myth
Some people are wary of car loans simply for fear that simply applying for the loan in the first place will hurt their credit. This is not true. If you obtain a car loan within about a month of applying while you are shopping around, then hard inquiries will not damage your credit score.
How a car loan can help your credit
Car loans can have a hugely positive impact on your credit score. In fact, many banking professionals consider car loans to be second only to mortgages as the best loans for your credit report. A car loan can help you credit score in a number of ways, including:
A car loan is considered good debt
Although all forms of debt can have a positive impact on your credit score, car loans are especially good. This is due to the fact that a car loan is known as “good debt”. This means that it is a low interest loan with few or no fees (unlike a credit card, which includes lots of interest and plenty of fees). That is why an installment loan such as a $20,000 car loan is received more positively by credit reporting agencies than half that amount in credit card debt.
Vehicle financing institutions love car loans
When applying for your next car loan, the biggest individual factor that a potential lender will consider is your car loan history. As such, a car loan is actually the best tool to help you get a better car loan in the future.
A car loan mixes up your credit
The credit reporting bureaus like to see that you can not only handle debt, but that you can handle different types of debt. In fact, a whole tenth of your credit score is determined by what different types of credit you use.
Making payments on time to various types of entities will also look good to banks for future loans.
A car loan is one of the strongest indicators of responsible credit use
A car loan is solid proof that you are using your credit for a responsible, practical reason. This contrasts strongly with a credit card, which can be used to pay for any practical or frivolous reason that is within the confines of the card’s limit.
Can a car loan negatively impact one’s credit score?
Although a car loan can be great for a credit report, it can also be severely damaging if it is used in the wrong way. Here are some ways that a car loan can do damage to you credit score:
- Missing monthly payments
Paying a car loan on time looks great on your credit report. However, missing one or more payments on a car loan has a strongly adverse impact on your credit. In fact, a car loan monthly payment is one of the worst bills that you can skip out on paying.
- Having too much outstanding debt
Too much debt on your credit report is not a good thing for your score. Credit reporting agencies consider an excessive amount of debt to be an irresponsible use of one’s credit. This is due to the fact that they know that your loans are not the only things that you have to pay for. You still have utilities, food, clothes, rent (if you don’t have a mortgage), etc to pay for in addition.
Although an auto loan is one of the best types of loans that you can obtain, it is still debt. As such, you credit score can actually be lowered if the credit reporting agencies feel as though your car loan forces your total debt volume to be too high for what they think is reasonable for your current income.
As it is with all types of loans, a car loan can be hugely beneficial for your credit score – if you treat it right
With the exception of a mortgage, a car loan is one of the best additions to your portfolio of loans to enhance your credit history and boost your score. However, as with all loans, you must use it responsibly; this means making your monthly payments on time and not taking on a are loan so large that it makes it ostensibly difficult to pay all of your bills.