Will Auto Financing Hurt Or Help Your Credit Score?
One of the least fun but most necessary elements of buying a car is auto financing. Of course, anything that involves your finances raises questions about how the purchase will impact your credit score.
Before you fill out that auto financing application, here are some things you should know about how purchasing a car impacts your credit.
The Most Common Factors That Impact Your Credit Score
While there are various factors that influence your credit score, there are five big ones that play the biggest role when seeking an auto loan:
– Payment history
– Utilization ratio
– Length of credit history
– New credit
– Types of credit
Typically, your payment history is the most critical part of your credit score. This history actually makes up about 35% of your FICO score, which is the most popular report used by lenders.
Utilization comes in a close second, making up about 30% of your credit score. Utilization compares your total available credit to your total outstanding balances. The former is the maximum amount of money you are able to borrow, while the latter is the total money you own. Typically, lenders like to see your utilization under 20%. That means if you’re credit limit is $10,000, you should borrow more than $2,000 per month.
Your length of credit history typically makes up about 15% of your total score. In general, the older your credit history, the better. That means it’s always wiser to leave credit cards open when it’s an option. Obviously, things like annual fees can make it tempting to close cards when they’re not in use. Sometimes simply downgrading the card to the free option can keep the account open.
New credit impacts about 10% of your credit score. That’s why you might see a dip in your overall score after applying for or opening a new account. New credit isn’t a bad thing, but it can impact things enough during a certain time frame. That’s why it’s not wise to open new accounts before applying for a more significant loan.
The final 10% of your credit score comes from the types of credit you have. There are two types of credit that you’ll see: installments and revolving. Installments are fixed loans that you pay each month, like an auto financing loan or mortgage. Revolving credit is an open line of credit with varying payment amounts each month like you find with a credit card.
Auto Financing And Your Credit Score
When you take out an auto loan, it will impact your credit score. This can be a good or bad thing, depending on you handle the loan. The negative parts of your auto loan primarily revolve around the reproductions of not making on-time payments. Yes, applying for car financing can cause a temporary drop in your score, but that is a minor issue. If you are late or miss payments, you not only risk seeing a huge drop in your score, but you could end up having your car repossessed.
Luckily, the positive impacts of auto financing outweigh the negative ones if you’re prudent. Paying your payment on time each month will greatly impact your payment history. You can also use your loan to build credit. For example, if you don’t currently have an installment account on your credit report, an auto loan will increase this area. Those with mistakes in their credit history can also rebuild their credit by making on-time payments.
While an auto loan certainly poses a risk to your credit, it can also be a huge help to those who pay on time.
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