How Will a Car Loan Affect My Credit Score?

Your credit score is one of the ways that lenders determine your creditworthiness as a prospective borrower. Your credit score is used when you apply for a personal loan to buy a car and when trying to secure dealer financing. It’s important to understand how automobile financing will affect your credit score. This article will break it down for you.

Understanding credit scores

The credit scoring system most lenders use is the FICO system, which references scores between 300 and 850. FICO uses an algorithm with five variables to calculate this score.ⁱ Those variables are listed below, along with the percentage of how they are weighted in the credit score calculation. Although, it’s important to note that everyone’s score changes often and is very unique to each individual:

• Payment History (35%)
• Amounts Owed (30%)
• Length of Credit History (15%)
• Credit Mix (10%)
• New Credit (10%)

Taking out a car loan can affect your FICO score in several of these areas. Simply applying for a loan can also affect your score. Let’s explore this more below.

The effect of credit inquiries

There are two types of credit inquiries. A “soft inquiry” occurs when your credit report is pulled, but you haven’t applied for credit. It can also be done as part of a prescreen to see if you fit the lender’s criteria to be considered for a loan. The deep dive into your credit history that follows produces another type of inquiry called a “hard inquiry.”

Soft inquiries don’t affect your credit score, but hard inquiries do. They’re recorded by the credit bureaus and typically result in a slight drop in your credit score. You may generate multiple credit inquiries while you are shopping around for the right car. If credit inquiries come within a 14 to 45-day window, credit reporting agencies typically count them as just one inquiry.ⁱⁱ

The effect of loan payments and non-payments

The “payment history” category represents 35% of your overall FICO score, making on-time payments the most significant factor in credit score calculation. The same can be said for missed payments and late payments. Lenders report those instances to the credit bureaus, and they will cost you points on your score. Late and missed payments also stay on your credit report for several years.

Making on-time payments on a car loan decreases the amount of debt you owe. This is tracked in the “amounts owed” category of the FICO credit scoring system, which is 30% of your overall credit score. Lenders will look at how much you owe whenever you apply for new credit, so paying the loan down consistently is important.

Other factors that affect your credit score

Getting approved for a car loan also adds to the “credit mix” category used in calculating a FICO score.ⁱⁱⁱ An example of a healthy credit mix is having an auto loan, a personal loan, a credit card or two, and a mortgage. The auto loan also counts as “new credit,” which may have a temporary negative effect on your credit score.

The bottom line

When considering how a car loan will affect your credit score, the most important step is to make your loan payments consistently and on time. Don’t worry about hard credit inquiries or new credit temporarily lowering your credit score—any lost points will be boosted by current, on-time payments.^iv Missing payments, however, does long-term damage to your FICO score. To avoid this scenario, budget your money carefully and stick to a schedule so you don’t miss your monthly payment due dates.

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