It’s common knowledge that taking out a loan or credit card will affect your credit score. But most people don’t realize that some types of loans can help their credit in the long run.
There are a number of reasons to have a good credit score. It can help you get approved for loans, including mortgages, private student, and personal loans, help you pay less on insurance premiums, and have lower interest rates and better terms on loans and credit cards.
If you have poor credit, it’s a good idea to work on increasing it now, as it can take a significant amount of time, even if you have no plans to apply for loans or open a new account. You can lower your debt to no more than 30% of your available credit, pay all bills on time, and avoid closing accounts unnecessarily to show a long history that will help improve your overall score.
How a Car Loan Affects Credit Scores
Many people are surprised to learn that taking out a car loan may positively affect their credit score. However, it’s essential to understand that the rise in credit isn’t instant; unfortunately, your score will drop initially.
When applying for a loan, a lender reviews your credit report, causing a hard inquiry on your credit report that will immediately show a dip in your credit score of at least a few points, typically five or less. These FICO score credit checks help lenders see if you qualify for a loan and what the term and interest rate will be.
However, a loan paid on time will help to quickly raise your store, even after the drop from a hard inquiry. It shows credit bureaus that you can make long-term on-time payments.
How Car Loans Show Up on Your Credit Report
When you take out an auto loan, the account is reported to the credit bureaus and becomes part of your credit history. The credit bureaus will look at two categories when listing your auto loan.
- Type of account: Auto loans are usually reported as an installment account. Other types of installment accounts are student loans and mortgages. Unlike credit card debt which is revolving, installment accounts have a set amount of payments for a set time and at the same amount.
A piece of your credit score pertains to the type of account it is. If you don’t have an installment loan on your report already, adding a new one, like a car loan, may help provide a range or mix of types of credit accounts types that help improve your overall score.
- Current status: The status of your loans plays the most significant role in determining your score. Being on time with car payments, your status remains current The more on-time payments you make, the better your overall score will be.
Those with previous late payments on their credit report will see the most significant change. That’s because payment history is typically only for the past seven years. For every new on-time payment, an old one will fall off of your report. In time, the late payments will disappear from your report, but only with the help of new payments.
How to Ensure You Raise Your Credit with a Car Loan
While no magic button will fix your score, a car loan can help raise your score. Done incorrectly, you could impact your score for the worse. Here are some tips to ensure you help your credit with an auto loan.
- Shop around for better terms. When applying for an auto loan, shop around to different lenders. Depending on your credit score, you may receive a wide range of interest rates, loan amounts, and term lengths. While it’s tempting to go with a lender with a shorter term length, it might be beneficial to have lower monthly payments for a longer period to ensure you can keep up with the payments.
- Choose only a loan amount you can afford. There’s no point in taking out a loan you can’t afford to help build your credit. Paying late or defaulting on a loan will hurt your score.
- Make full, on-time monthly payments. Don’t get into the habit of paying late or a lesser amount. Set up autopay if you often forget, and make sure you can afford your monthly payments before taking out the loan. If you’re having trouble making payments, reach out to your lender to see what you can do to stay current.
Learn More About Credit Scores with Finance is us
Many factors influence your credit score like payment history, utilization ratio, types of credit, and the length of your credit history. A car loan can help boost your credit score by adding a new type of credit to the credit cards you may have on your account. As long as you make total, on-time payments, it can also help with your payment history, which is one of the most significant factors in determining a credit score.
For more help with raising credit, follow the Finance is us blog. We can help you understand the factors determining credit scores and how to raise your credit to ensure a better interest rate or insurance premiums.
Disclaimer: All content on this site is information of a general nature and does not address the circumstances of any particular entity or individual, nor is the information a substitute for professional financial advice and services.