Does Buying a Car Help Your Credit?

If you just bought a car and took out an auto loan to purchase your car, you might be wondering whether buying a car or financing one will your credit? We will answer this question in much detail below.

Does Buying a Car Help Your Credit?

Yes, buying a car and taking out a loan to do so can help your credit score so long as you make all of your car payments on time. If you miss even one payment on your auto loan, you can cause significant damage to your credit score.

Hard Inquiry

When you first apply for a loan to buy a car, you might notice a small drop in your credit score. This drop is totally normal and your credit score will recover fairly quickly after making a few payments on your auto loan. When you first apply for a car loan, a hard inquiry is placed on your credit report. A hard inquiry is placed on a person’s credit report whenever he or she applies for a loan.

Hard inquiries can lower your credit score by 5 to 10 points. That said, hard inquiries will only remain on your credit report for 2 years from the date they were added. After the 2 year period, they’re automatically removed from your credit report.

If the auto dealer you purchased your car from shopped around for loans, you may have noticed several hard inquiries because each lender requested to review a copy of your credit report. That said, you should not worry too much as these inquiries will all be counted as one inquiry, provided that they were made within a short period of time.

Addition of Account to Your Credit Report

Once you take out a loan to buy a car, your loan account will be added to your credit report. When the loan account is first added, you might notice a small drop in your credit score. You should ignore this small drop and focus on making payments on your car loan. Within a few months of making timely payments, you will see an improvement in your credit score.

Credit Mix

Buying a car can help your credit because it diversifies the mix of credit accounts on your credit report. The credit reporting bureaus reward those with more diverse accounts with a higher credit score. An auto loan will appear on your credit report as an auto installment loan, this creates a more diverse credit mix, which will help your credit score.

The credit reporting bureaus reward people with more diverse credit accounts with a higher credit score because they have demonstrated that they have experience handling different types of accounts, such as credit card accounts, auto loans, home loans, and student loans.

Should You Take Out a Loan to Buy a Car?

If you’re like most Americans and you don’t have the money to buy a car in cash or just don’t want to put down all of your cash to buy a car, you’re likely going to take out a loan to finance your car purchase. Although purchasing a car without going into debt is your best option, we understand that not everyone has the money to do so.

If you need a car and know that you can comfortably afford the monthly payment, you should go ahead and purchase a car. However, if your employment situation is not steady and you don’t know whether you can make the payments on time, you should stay away from purchasing a car because you will destroy your credit if your car is repossessed for nonpayment of your auto loan.

You Should Consider the Following Factors When Taking Out a Loan to Buy a Car

Before taking out an auto loan to buy a car, you should make sure that you’re getting a good deal on your loan. You should consider the purchase price of the car, your monthly payment, the interest on your auto loan, and the repayment terms of the loan.

Purchase Price / Monthly Payment

The most important thing to consider when financing a car is the cost of the car. You should select a car that you can afford. You should select a car with a reasonable price so that you have a payment that you can afford every month. Your payments history accounts for 35% of your credit score, so making payments will definitely boost your credit. However, if you miss payments or default on your car loan, you can cause significant damage to your credit. So, be cautious and select a reasonably priced car that you can afford.

Interest Rate

The second most important factor that you should consider when buying a car is the interest rate on the loan. The interest rate is a portion that not many people pay attention to, but can end up costing you a ton of money in the long run.

For example, if two people purchase a 2021 Nissan Maxima with a sticker price of $35,000, and one person has an interest rate of 3.95% and another person purchases the same car with an interest rate of 12.95%, the following will happen:

The person financing the Maxima at 3.95% will have a monthly payment of $644 for a 60 months, and the person financing the Maxima at 12.95% will have a monthly payment of $795 for 60 months.

At the end of the loan, the person who financed the Maxima at 3.95% would have paid $38,627, while the person who financed the Maxima at 12.95% would have ended up paying $47,728 for the same car. So, you should definitely pay attention to the interest rate as it could end up costing you thousands of dollars more.

That said, no everyone will qualify for a decent interest rate. The interest rate largely depends on your credit score. The better your credit score, the better the interest rate that you’ll qualify for. If you have a credit score of 740 or more, you will likely qualify for the best rates, and if you have a credit score of 680 or more, you may qualify for an ok interest rate, but not the best rates.

Payment Term

Don’t get fooled by a low monthly payment if the lender is placing you on a lengthy auto loan. Any repayment term beyond 5 years increases the likelihood that you’ll default on your loan. This is so because the average vehicle warranty only lasts for 4 years. If the term of your loan is 7 or 8 years, you’ll be driving the car without a warranty, and the components of your vehicle may fail 4 to 5 years after you purchase it, so you’ll not only have to worry about making car payments, but also worry about expenses to repair your car.

Additionally, the lengthier the term of your car loan, the more you’ll end up paying interest, and this could add up to thousands of dollars by the time you end up paying off your car. So, try to choose a car loan term that does not exceed the recommended 60 months.

Credit Score Planet Frequently Asked Questions

1. How long does it take for my car payments to improve my credit?

Your car payments will begin to improve your credit score in as little as one to three months.

2. How much will a car loan drop your credit?

Initially, a car loan can cause a small drop in your credit score that should not exceed 30 points. That said, this drop is temporary and if you make your payments on time, you will see your credit score improve significantly within just a few months.

3. Does a car loan build credit?

Yes, car loans are reported to the credit reporting bureaus. So, if you make your payments on time, you will build credit.

4. Will my credit score drop if I finance a car?

Your credit score may drop initially, but it should improve within a few months of making timely payments on your car loan.

5. Does applying for a car loan hurt my credit?

Merely applying for a car loan can cause a small drop in your credit score (5 to 10 points) because a hard inquiry is placed on your credit report. That said, don’t worry too much as hard inquiries will only impact your credit score for 12 months, and within 2 years they’re automatically removed from your credit report.