Car financing can help improve your credit score if you keep your payments on time. But it can also hurt if you’re not careful. In this guide, we’ll show you how car financing can help raise or lower your credit score so you can avoid costly mistakes.
Why is a construction loan so important?
Credit is king in the US. You need it for everything from getting a good interest rate on a loan to saving money on car insurance. Good credit is how you prove to lenders that you are reliable and trustworthy. This is how you show them that you can repay debts. A good credit score leads to lower interest rates on loans, which leads to more money in your pocket over time. On the other hand, a bad credit score can make it harder to get a loan and lead to higher interest rates and fees. Read more: Understand the credit requirements for auto loans, get the best rate
How car financing works help your credit score?
Now that you know why you need to have a good credit score, let’s talk about how car financing can help you get there. When you finance a car, you are essentially taking out a loan to pay for the car. This will help improve your credit score in two ways:
1. Strengthens your payment history
Payment history is EVERYTHING in the credit world (it makes up 35% of your total score). Pay even one bill late and it can do some damage. But if you make monthly payments on time and in full, the credit gods will shine down on you from heaven. And you will be rewarded with a credit score that gets bigger and bigger over time.
2. Diversifies your credit balance
Having an installment loan (such as a car loan) helps diversify your “credit stack”, which in turn can also help boost your score. What is a credit mix? It’s just a fancy way of saying that you have different types of credit accounts. So instead of having all the credit cards or all the student loans, you have some variety. And remember those credit gods from the past? They believe diversity is the cherry on top of a good credit score.
How car financing works to harm your credit score?
While car financing can help improve your credit score, it can also hurt your credit score. Here are some examples:
1. Difficult questions temporarily lower your score
Every time you apply for an auto loan, the lender carefully reviews your credit report to see what rates you qualify for. These tricky questions can temporarily lower your score. And they can stay on your credit report for up to two years. The good news is that if you’re making multiple complex requests in a short amount of time, they usually only count as one request. For example, FICO considers any serious requests made within 30 days to be one request.
2. Missed payments stay for a long time
If you miss payments or don’t pay off your car loan, it can also hurt your credit score. So, when financing a car, make sure you can afford the monthly payments. Otherwise, you may be doing more harm than good to your credit history. Read more: The 5 biggest mistakes people make when buying a car
6 questions to ask before buying a car
Financing a car is a really big deal. Before you do this, make sure it’s the right financial move for you. If you feel stuck, here are a few questions to ask yourself (and your dealer):
- How much can I afford to spend on a car?
- What interest rate will I apply for?
- How long do I want the loan to be?
- Will I have a down payment?
- What fees will be included in the car price?
- What else do I need to know about the funding process?
Answering these questions will help you avoid mistakes that could damage your credit score. For example, a 60-month loan may have a lower interest rate, but if the payments are too high for your budget, you can skip a payment or refuse the loan entirely. In this case, you may be better off buying a cheaper car or taking out a 72-month loan. Read more: How to finance a car wisely
Tips for improving your credit score over time
There is no quick and easy way to improve your credit score. However, with time and perseverance, you can watch it happen with the following tips:
- Make all your payments on time, including car payments, credit cards, mortgages, and more.
- Try diversifying your loan portfolio by using different types of loans such as car loans, student loans, and credit cards.
- Keep your credit card balances low. Ideally, you should use less than 30% of your credit limit.
- Check your credit report regularly for errors and challenge any inaccuracies you find.
Read more: How to build credit
What to do if you’re struggling to pay for your car
If you have already financed a car and are having difficulty making payments, you have several options:
Refinance your loan
If you have good credit, you can qualify for a lower interest rate by refinancing your loan. This can lower your monthly payments and make it easier to buy a car. Read more: How to refinance a car loan in 7 steps
Trading on your vehicle
If you roll over your credit (meaning you owe more than the car is worth), you can trade it in for a new one and convert the negative equity into new credit. Read more: Auto Dealer Secrets: How to make sure you’re getting a fair trade-in deal
Sell your car
You can also try to sell your car and use the money to pay off the loan. This can be tricky if you’ve rolled over credit, and it may not work if you don’t have other transportation. However, it might be worth a try. Read more: The 5 Best Ways to Sell Your Car (In Terms of Ease, Value and Convenience)
Postpone payments
Some lenders may offer programs that allow you to defer payments for a month or two. This can help if you are experiencing temporary financial setbacks. However, during this time, interest will continue to accrue, so you may end up paying more.
Get help from a credit advisory agency
If you are struggling to make ends meet, you may want to consider getting help from a credit counseling agency. These agencies can work with you to create a budget and come up with a plan to get out of debt. Regardless of which option you choose, be honest and upfront with your lender. They may be willing to work with you to find a solution that works for both of you.
Summary
Car financing can help or hurt your credit score depending on how you manage your credit. If you are thinking about financing a car, make sure you understand the process and can afford the payments. And if you’re struggling to pay for your car, there are options to help you get back on track. Featured Image: Standret/Shutterstock.com