The purchase of a vehicle is a major life event, but can also affect your credit score. Your decision on whether or not to use a car-loan for your next purchase will depend on a number of factors.
A car loan will help you improve your FICO score and build your credit history. A car loan may also enable you to refinance a mortgage or other loans in the future at a lower-interest rate.
How does an auto loan affect your credit?
Your credit score is based on many factors, including your payment history and the length of your credit history. Having a long credit history and on-time payments can increase your credit score.
One of the main things that your credit score looks at is your credit utilization ratio, or the amount of revolving debt you have relative to your total credit limits. Having too many revolving accounts can reduce your credit score. To avoid this, keep your balances down and pay them off as soon as you can.
Another factor your credit score considers is your credit mix, which reflects the different types of credit you have. The goal is to balance your debt between revolving and installment credit such as a credit card or a mortgage.
You can improve the mix of your credit by applying for new revolving debt, like a card. However, it is not necessary to apply for everything at once. It could send a bad message to lenders about your financial situation.
Your credit score is also affected by the length of your history of credit and the age your accounts. Financing a new car can cause your average account age to decrease slightly, which can have an adverse effect on your length-related scoring factors.
Your credit score can be negatively affected by the amount of money owed. This variable accounts for 30 percent of your credit rating. Your total debt increases if you add another installment loan to the credit report.
It is common for people to pay off their car loan early. Paying off an auto loan early can affect your credit score negatively.
Keep your auto loans open by making timely payments. This has a positive influence on the scoring factors related to length, which account for 15 percent of your credit score. Your average account age drops when you close an auto-loan because it is no longer considered a live account.
It is possible to improve your credit rating by getting a new loan. This will help you establish an excellent credit history, with a history of reliable payments. Keep in mind, however, that a new auto-loan can have a long time to improve your credit score.