June 5, 2023
Most car shoppers don’t have the means to buy a vehicle outright unless they have been saving for some time. Fortunately, financing is a viable option for eligible borrowers — but it begs the question that we often hear: “Does financing a car build credit?” The short answer is no; the loan itself doesn’t build credit, but making your monthly loan payment consistently on time over the life of the loan does help your credit.
In this article, Dick Hannah demystifies some confusing concepts and questions about car loans and credit so that you, as a car shopper, can feel confident buying a car and preserve the health of your credit score after the fact.
Here’s a quick look at how a car loan can have positive and negative impacts on credit:
Let’s take a step back for a moment and talk about credit scores themselves. What is a credit score? Simply put, it’s a three-digit number assigned to every consumer that reflects creditworthiness based on several factors. Experian, Equifax, and TransUnion are the three major credit bureaus lenders use to obtain a consumer’s credit information. Credit scores usually range from 300 – 850, with 850 being pristine credit and 300 being very poor. The factors used to calculate your credit score include:
When your credit score is on the high end of the range, it shows lenders that you pose a low risk to them and that they’re likely to make back their investment. That’s why strong credit increases your chances of getting loans and favorable interest rates.
Financing a car involves taking on new debt, which affects your credit score. But beyond this simple cause-effect relationship we’ve already discussed, your credit is also impacted by the way you finance your car:
Consider these factors carefully before you take on a car loan so you know how to avoid derogatory marks on your credit score and effectively manage the debt.
Did you know that payment history accounts for 35% of your credit score? Considering that this factor has the most weight in your scoring calculations, on-time auto loan payments can do wonders to help you boost your credit.
Approximately 10% of your credit score is determined by your credit mix or how much revolving credit you have compared to installment loans.
Adding an installment loan like an auto loan can help you diversify and improve your score if you have mostly revolving credit. So, does a car loan build credit? In these ways, it does.
Compared to traditionally riskier avenues of borrowing, like high-interest credit cards, auto loans can be an excellent way to build your credit if you manage your money responsibly and avoid taking on too high of an auto loan payment. Stick to vehicles within your budget, and make sure to shop around with multiple lenders to find the best deals on interest rates for your situation.
After identifying a reasonably priced car and obtaining a loan with terms that work for you, you’ll make regular payments over time and demonstrate to lenders that you can manage debt responsibly, thereby building a positive credit history.
Yes, paying off your car loan can lower your debt and free up your income, giving you a lower debt utilization ratio that can positively impact your credit. Be wary of the adverse short-term effects, though, as closing accounts decreases the age of your credit and can lower your score. And if you decide to pay off the loan early, you’ll lose the benefits of building a long payment history that can bolster your score.
Many people get a car loan to build credit. But despite the many benefits of car loans, they can also be a detriment to your financial health if you drop the ball with your payments. If you miss a payment or pay late, your history will be dinged, and your credit score may drop. This late payment will appear on your credit reports for up to seven years! Likewise, taking on too much debt can force you to default on the loan and land you in collections, dropping your credit score and making it harder to qualify for loans in the future.
The car financing process can be tricky to maneuver, especially if you have limited experience and don’t know what to watch out for. If you plan on obtaining an auto loan soon, keep these things in mind before finalizing any paperwork.
Before jumping straight into the financing process, we’ve devised a list of questions you should have the answers to so you can ensure that the financing experience is a positive one that benefits you:
Over the term of your loan, your life’s circumstances may change, whether due to the loss of a job or change in salary, a divorce, or some other situation that impacts your available income. If this is the case and you’re now struggling to pay your auto loan on time every month, don’t worry — there are several ways you can avoid defaulting on the loan:
If your dream car has shown to stretch your budget too thin, trading it in for a less-expensive one is a good way to lower your monthly payment. Just keep in mind that you may end up with negative equity and owe more on your auto loan than the trade-in vehicle is worth.
If you don’t need the car you financed, you may be able to sell it to pay off the loan and avoid default and damage to your credit. Many dealerships are willing to purchase cars that meet their resale criteria — if the vehicle has low mileage, is in good condition, and has records of all service and accidents the car has been through.
Refinancing is when your lender replaces your current loan with a new one with better terms for your situation. If your car loan is stretching your money too thin, your lender may be able to lengthen the term so your monthly payments are lower — although this will raise the total interest you pay over time.
In times of temporary financial turmoil, some lenders may allow you to defer paying on your auto loan for a few months without defaulting. Interest will continue to accrue during this time, but it will at least allow you to catch up financially until you’re back in a stable position. Many financial institutions also offer “skip-a-payment” programs during the holiday season to free up their borrowers’ incomes for holiday gifts.
When you feel like you’re out of options and your auto loan is becoming too much to manage, you’re not alone. The job of a credit counselor is to help you develop a plan tailored to your life and finances. Seek one out who can help you negotiate with your lender, find room in your budget to cut back, and identify other debt management solutions, including educational resources that will empower you to make better choices with your money moving forward.
Did you know Dick Hannah Dealerships is the No. 1 specialist in bad credit car loans? If you’re struggling to get into a vehicle because of your credit score, we can help you get approved for financing, sell your car, and more. Get in touch today!Contact Us