Boost Your Credit Score with a Car Loan
Buying a car is one of life’s biggest financial decisions. Here’s how you can use a car loan to your advantage when it comes to building credit.
A shiny set of tires. All the latest bells and whistles. And that new car smell. Buying a new car can be its own reward. Plus, a new car loan can help boost your credit score in the long term – if you know how to manage it well.
Credit Scores and Car Loans
Paying your bills in full and on time is the single most important thing you can do to build credit history and increase your credit score.
Once you are behind the wheel, you’re less likely to have your credit score on your mind. But how you manage the auto loan that made your new ride possible will affect your credit score. A credit score is a three-digit number that provides a quick snapshot of your financial habits. Your credit score is used by lenders to determine if you are a good risk and someone who is likely to repay a loan.
There are five factors that affect your credit score and the percentage of your score they represent:
1. Payment History (35%)
This is the main consideration in your credit score. Paying your bills on time and in full raises your score because it demonstrates that you are a good risk. A lender who writes you a loan can be pretty sure they will get their money back.
2. Credit Utilization (30%)
This is how much of your available credit you’re using. It’s determined by subtracting the balance on your credit cards from your credit limit. You can find your current available credit on your credit card statement. You should keep your credit utilization under 30%. If you have a $1,000 credit limit, that means not carrying a balance of more than $300. Maxed out credit cards, even when you make the minimum payments on time, may lower your credit score. Using more than 30% of your available credit could indicate you are overextended and in danger of defaulting.
3. Credit History (15%)
When you’re just starting out, you have no credit history, which makes it hard for lenders to determine if you are a good risk or not. Over time you build credit history by using credit responsibly. The longer you’ve been responsibly repaying debts, the higher your score.
4. Credit Mix (10%)
Lenders like to see that you are capable of managing various types of credit before adding another financial responsibility. Having a few different types of credit, like credit cards, loans, and a mortgage, is ideal.
5. New Credit (10%)
Too many credit applications within a short time can lower your score. When you apply for a new car loan, your lender will make a hard credit check which is also known as a “hard inquiry” or a “hard pull.” This may temporarily lower your credit score by a few points. Multiple hard credit checks can start to add up. But you don’t need to worry if you want to shop around for the best car loan, comparing, for example, loans from your financial institution or from your dealership. If you’re rate shopping and find a loan within 30 days, all of those inquiries will only count as one hard check.
Manage Your Car Loan to Boost Your Credit Score
Your new car loan can benefit your payment history and credit mix, two of the factors that go into your credit score.
Paying your bills in full and on time is the single most important thing you can do to build credit history and increase your credit score. Your car loan is no exception. Put the due date on your calendar or set up automatic payments from your checking account. If you stay current on your loan, it’ll be marked “paid as agreed,” and that status can be a huge benefit to your score.
Your car loan can also improve your credit mix, especially if your only other credit is in the form of credit cards. Credit comes in two basic types: revolving and installment. Credit cards are a common example of revolving credit. Your balances and payments change from month to month. Car loans are installment accounts. They’re issued for a certain amount, and you repay the same amount every month. Most lenders prefer borrowers who can show they’re good at managing both types of credit. That’s why if you diversify your credit mix, your credit score is likely to go up.
A new car can help you get where you want to go if you know how to handle it. And the same goes for a new car loan.
When you’re ready to take the next step, contact your trusted financial institution to get pre-approved for an auto loan.
