Taking out an auto loan can raise your credit score. However, how fast a new car loan raises your credit score depends on the status of your credit report.
In this guide, you will learn:
- •How a Car Loan Affects Your Credit
- •How an Auto Loan Can Improve Your Credit
- •How Fast a Car Loan Can Raise Your Credit Score
- •Requirements to Qualify for a Car Loan
- •Other Ways to Build Credit
How a Car Loan Affects Your Credit
Applying for a new car loan will ding your credit score temporarily. However, you can offset this initial impact by making regular timely payments.
Here are three ways a new car loan can affect your credit score negatively:
A hard inquiry on your credit report
The immediate effect of applying for a car loan is a temporal drop in your credit score. Applying for a new loan or credit card often results in a hard pull on your credit which impacts your score negatively.
How negatively a new car loan impacts your credit will depend on your credit history.
If you have a long and good credit history, the drop may not be more than 5 points. However, you can experience as high as a 15-point drop if you have a shorter and less stellar credit history.
To alleviate the impact of a hard pull on your credit score, try to include all inquiries within two weeks and credit agencies will treat your multiple inquiries within that period as a single inquiry.
So shop around for the best rates you can find and make all your applications within a short period of time. If you have bad credit, then you may want to consider the best car loans for bad credit.
Lowers the average age of accounts
A new car loan decreases the average age of your credit accounts. This is because adding a new loan to your older accounts will lower the average age of your credit accounts.
However, this disadvantage becomes an advantage over time because you are aging that account with each month you hold it.
Increasing amounts owed
A new car loan increases the total amount you owe. This can have a negative effect on your credit score because amounts owed are one of the key factors used in FICO score estimations (it accounts for 30% of your FICO score).
Again, this initial disadvantage becomes an advantage if you make regular timely payments.
How an Auto Loan Can Improve Your Credit
Although a new car loan affects your credit at the onset, it can improve your credit score over time by diversifying your credit mix and improving your payment history if you make regular timely payments.
A better payment history if you pay your loan on time
Payment history is the most important consideration in FICO score estimations. It accounts for 35% of the scoring model used by FICO.
This means that making regular timely payments on your car loan will have the biggest impact on your credit-building effort.
If you maintain a record of consistent timely payments, you will see your credit score rise over time. On the flip side, late or missed payments will have a negative impact on your credit score.
An improved credit mix
A new car loan can improve your credit mix especially if you have never had a car loan before or some other type of installment loan (like a mortgage).
For example, if you have only used credit cards, adding a car loan will enhance your credit mix.
Since credit mix is part of the scoring formula used for estimating credit scores, an improved credit mix will impact your score positively.
A good credit mix consists of different types of debt and proves that you can responsibly manage multiple payments at the same time.
As you are paying off your car loan, you are not only showing that you have a good credit mix but you are also showing that you can handle the credit mix by making regular timely payments on the different loans you have.
A car loan will not have a positive impact on your credit score if you are doing negative things with credit cards or other loans that you might have.
How Fast a Car Loan Can Raise Your Credit Score
How fast a new car loan improves your credit score depends on your credit history. To estimate how fast a car loan will raise your credit score, consider the following:
How long it takes to correct certain credit issues
Research published by FICO and CNBC shows how long it takes to correct certain credit issues.
| Starting Score | |||
| Event | ~680 | ~720 | ~780 |
| Bankruptcy | ~5 years | ~7-10 years | ~7-10 years |
| Home foreclosure | ~3 years | ~7 years | ~7 years |
| 30 days late mortgage | ~9 months | ~2.5 years | ~3 years |
| 90 days late mortgage | ~9 months | ~3 years | ~7 years |
While minor delinquencies like a late mortgage payment can take anywhere from three to nine months to recover from the resultant drop in your credit score, major delinquencies like defaulted payments can take up to eighteen months to recover from.
More serious delinquencies like home foreclosure and bankruptcy can take three and six years respectively to recover from the resultant drop in your score.
You can keep track of your credit-building efforts by keeping a close eye on your credit report. A good way to do this is to set alerts under your accounts with the major credit agencies so you will be informed of new updates.
How long it takes for a car loan to appear on your credit report
After you have made up your mind on which auto loan company (or dealership) to go with and closed the deal, it can take up to thirty days (from the start of the billing cycle) for your new car loan to appear on your credit report.
At first, this will ding your score due to the size of the debt but you can expect your score to rise over time if you portray good credit habits.
Factors that affect your credit score
To get a better understanding of how a car loan affects your credit score, consider the following factors used to calculate your credit score:
- Payment history (accounts for 35% of your score)
- Amounts owed (accounts for 30% of your score)
- Length of credit history(accounts for 15% of your score)
- Credit mix(accounts for 10% of your score)
- New Credit (accounts for 10% of your score)
Requirements to Qualify for a Car Loan
Common requirements
You need a good score to qualify for auto loans with good rates. If you have bad credit, then you may want to consider the best car loans for bad credit. Other common requirements to qualify for an auto loan include:
- A minimum income requirement
- A Debt to Income (DTI) ratio requirement
- Proof of insurance
- Eligible vehicle
- State-issued ID
- Proof of a residency
Minimum credit score to qualify for a car loan
There’s really no minimum score required to apply for a car loan. However, the higher your credit score, the higher your chances of being approved.
Other Ways to Build Credit
Here are alternative ways to build credit:
- Consider a credit builder loan
- Apply for a secured credit card
- Become an authorized user
- Try Experian Boost or UltraFICO
Compare the best auto loans
FAQs
Do car payments build credit?
Yes, car payments can help you build credit if you make regular on-time payments.
What credit score should I have to buy a car?
There’s really no minimum score to apply for a car loan. However, the higher your credit score, the higher your chances of being approved.
How much income do I need to get approved for a car loan?
Most lenders will require a minimum gross income of $1,500 to $2,000 a month to qualify for a car loan
How long does it take for a car loan to raise my credit score?
How long it takes for a car loan to raise your credit score depends on your credit history.
Sources
- Experianaccessed on November 6, 2022
- Consumer.govaccessed on November 7, 2022
- FICOaccessed on November 7, 2022
- CNBCaccessed on November 7, 2022
