People often don’t get enough information about building and maintaining credit, which has made it difficult for today’s adults to maintain good financial standing. People are riddled with questions like: “Does checking my credit score lower it?” “Does paying rent build credit?” “How do I repair my low credit score?”
Getting an auto loan is one accessible method to increasing your FICO score. At first, it might seem counterintuitive–after all, it will add a new account to your credit report and increase your amount owed, as well as shorten the length of your credit history. But as long as you consistently settle your monthly payments towards an auto loan on time, it will ultimately leave a positive impact on your credit.
How Does an Auto Loan Affect Credit?
Initially, when you open a car loan, you might see your credit score take a slight dip. This is the effect of lenders performing a hard credit check, which lets them calculate the rates and terms they can offer you. It’s important to note that any credit inquiries will appear on your report, but these shouldn’t affect your score significantly.
As long as you pay your auto loan on time each month according to the agreement you’ve made with your lender, an auto loan will effectively raise your credit score. This is because it boosts four out of five of the main factors that affect your credit. These include:
- Payment history: An auto loan can help you build a track record of paying on time.
- Credit usage: An auto loan can show that you know how to manage your debts.
- Length of credit history: An auto loan can exhibit your good financial activity over time.
- Credit mix: An auto loan can diversify your credit mix, which bodes well for your score.
That said, you may see adverse effects if you’re inconsistent with your payments, such as if you pay late or constantly miss your due date. Plus, if you don’t communicate with your lender, you could be at risk of getting your vehicle repossessed.
How to Build Credit with an Auto Loan
Building or repairing credit with an auto loan will take some time. Here are some tips to help you get started:
Find a Reputable Lender
Make sure that you get an auto loan from a lender you can trust–one that will report your credit to the bureaus. Avoid ‘buy now, pay later’ car dealerships that lure you with in-house financing options. These often hide high-interest loans and are designed to make you default.
Stay Under Budget
Just because you’re approved for a large loan doesn’t mean you should take the maximum amount; you can spend as little as you want. It’s recommended to borrow less than your budget.
Always Pay on Time
Your payment history is the most influential factor in your credit score (about 35%), so the most important thing to do when using an auto loan to build credit is to pay on time each month. If you can, pay more when possible, especially when you’re given the choice to pay towards your principal. This can reduce your interest and decrease your loan-to-value (LTV) ratio, which can further put you in good credit standing.
Missed or late payments will negatively affect your credit score. In case you can’t meet your obligations for the month, you can try working something out with your lender for alternative solutions–but know that not all lenders will offer partial payments.
Build Credit with The Phenix Group
Getting an auto loan is just one way to build or repair your credit. The Phenix Group can help you explore different options to boost your credit score and keep you in good financial standing. Get in touch with our experts today!
Wondering how much it costs to fix a credit score? We’ve got your back–check out our latest post.