Taking out a new car loan can be a bit of a tightrope act. Depending on your financial stability, the loan can make or break your credit.
Paying on time is an easy way to elevate your score, but late payments can quickly sneak up on you.
This means the most important consideration for a car loan (or any loan for that matter) is how to borrow within your means.
Following that golden rule will determine the lasting effects a car loan will have on your credit score — which can range from positive to detrimental.
How a Car Loan Can Improve Your Credit Score
One of the best overall ways to improve a credit score is to create a credit mix of revolving credit accounts, like credit cards, and installment loans, like student loans, mortgages, and car loans.
Car loans are a great starting point for many people looking to establish credit history through installment loans. An auto loan is much less of a financial investment than other borrowing options, like a mortgage, and they don’t affect your credit utilization as credit cards do. However, it still helps you build credit.
If you’re seeking a car loan and already have a good credit score, you’re ahead of the curve. Those with established credit can secure a car loan with lower interest rates. And that can save you thousands over the lifetime of the loan. It’s a good idea to build up your credit history so that you can lower your payments.
Anytime you take out a loan, it will affect your credit history. Whether it has a positive impact or not comes down to your spending habits. You may take out a loan with good intentions, but if you don’t make your monthly payment on time, it can really damage your credit scores.
There are some key strategies to consider to increase your credit score if it’s no longer in the budget.
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Will a car loan negatively affect my credit score?
As with any other type of loan, borrowing outside your means will negatively affect your credit score. Even one or two late payments can imprint you with a high-risk reputation.
While it might not seem like a big deal at the time, they can lead to a low credit score. They can negatively impact your chances of borrowing and impact your interest rates down the line.
Of course, unforeseeable circumstances happen, but there is a way to be proactive if your finances take a wrong turn. If you’re able to anticipate a late payment, it’s best to get in front of it as soon as possible.
Call your lender and explain the situation. Together you can figure out a plan to keep the credit score on the right track and prevent the occasional hiccup from tanking your credit score.
Know When to Refinance
Every late payment is incrementally affecting your payment history and credit score. If you’re stuck in this common situation it might be time to refinance your car loan.
There are several practical reasons to refinance an auto loan, but two major ones include:
1. Your credit score has improved
A credit score can go through a lot of changes over a couple of years. If you bought a car with a low (or nonexistent) score, and it has since improved, you can garner a lower interest rate by refinancing.
Even if it is only a couple of percentage points lower, a minor interest rate adjustment will still save you a lot of money over time. If your credit report is teetering you may want to consider partnering with a credit repair company. They can help you get back on track and jumpstart the process of rebuilding your credit score by dealing with your creditors and the major credit bureaus for you.
2. Personal finance trouble
In the event of a financial setback, refinancing will reduce monthly auto loan payments. Granted, this method will make the auto loan drag on longer, but at least this way, you can afford payments and preserve your credit score.
Refinancing is a great way to hit the restart button on an auto loan. Whether your finances have improved or deteriorated, refinancing caters to both poles of the credit spectrum.
Keep in mind, there are a few circumstances when refinancing isn’t an option. For example, if the value of a car is less than the initial auto loan, refinancing is not an option.
If you are “upside-down” on a car loan, you might need to reevaluate your assets. Many people caught in this situation will sell their cars to help pay off the loan. Then, they handle the remaining negative equity with an additional loan.
This cycle of borrowing should be avoided at all costs to preserve your credit score. So, if the cost of an auto loan is approaching the value of the car, it might be time to jump ship. You can check the value of a vehicle through online resources like Kelley Blue Book.
How to Shop for a Car Loan
When you’re borrowing a significant amount of money, you will want to find the lowest interest rate possible. During this process, you will likely allow several auto lenders to run credit checks.
Multiple credit checks will deduct points from your credit score under normal circumstances, so excessive hard inquiries should be avoided. However, when it comes to auto loans, there is an exception.
Multiple Inquiries for the Same Type of Loan
If all credit checks are done within a 30-day period all hard inquiries listed on your credit report will be treated as one when your FICO score is calculated.
You will have to commit to one hard inquiry, which will shave about 5 points off your FICO score. But, that’s a small price to pay to find a low interest rate loan.
An excessive amount of credit checks can slowly chip away at your credit score. So, make sure to keep your auto loan search brief to benefit from the 30-day credit check bundling.
Buying a car is a big investment and can have a major impact on your credit. Depending on how the loan is handled, the lasting effect can vary.
Car loans can be a great way to diversify your credit. You can begin building your credit score with regular installment loan payments.
If you are honest with yourself about borrowing potential then monthly payments should be a breeze. By making on-time payments without issue, you will be able to gradually build your credit score. If financial hardship gets in the way of lofty goals then it might be time to reevaluate.
Staying in touch with your lender on a case-by-case basis can help mitigate issues and prevent long-term issues. No matter what the outcome might be, be sure to always borrow within your means and remember how the car loan will gradually impact your credit score.