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Credit scores take a slight dip when you open any new line of credit, including car loans. But don’t let that stop you from getting the whip of your dreams.
Any negative effects from opening a new credit line can easily be corrected by making your payments on time and proving yourself to be a trustworthy borrower.
How Much Will A Car Loan Drop My Credit Score?
Applying for a car loan requires a type of “hard inquiry” on your credit. Hard inquiries drop your score roughly 5-10 points for about a year.
In most instances, this 5–10-point drop is not a big deal, but if you are on the cusp of “excellent,” “good,” or “fair”, this might make the difference in the category classification- thereby affecting the type of interest rate or loan terms you are offered.
Multiple hard inquires on your credit score in a 14–45-day period the credit bureaus usually count as a collective one hard inquiry.
This means you can shop around for a loan without worrying about dropping points like a basketball game.
This does not mean you should take out multiple loans in one year, though, because every loan you take will drop your score by 5-10 points. It is best to only acquire one loan a year.
Will Taking Out a Car Loan Affect My Credit Score?
The short answer to this question is yes. However, it will affect your credit from both a positive and negative standpoint over time.
Let’s address a couple ways for it to do that:
- Length of Credit History: In simplest terms, this means the amount of time that you have held credit accounts. These accounts could be loans, credit cards, or other debts reported to the credit bureaus. You might be wondering why this matter. Length of credit history indicates your habits around your debt. Do you consistently pay your bills on time? Do you use your credit frequently? Have you been in good standing for a long time? The length of your credit history shows consistency, and consistency shows future potential.
Taking out a new credit loan will drop the average age of your accounts which is how the length of your credit history is calculated.
It is not the end of the world, but it will impact your overall averages. If you have a long-standing credit, a car loan’s impact will be less than if you just got your first credit card a year ago.
In order to figure out your average age of accounts, you add up the length of time you have held each of your accounts in years and divide by the number of accounts.
10 + 8 + 5 + 10 + 2 = 35 / 5 = 7-year average
Now to see how opening a car loan would affect your average, let’s add in a new car loan:
10 + 8 + 5 + 10 + 2 + 1 = 36 / 6 = 6-year average
In this instance, adding in a new car loan only decreases the average age of accounts by one year, which would hardly upend your credit history.
- New Credit: New credit means those hard inquiries on your credit. Anytime you allow someone to pull your credit for a loan, it will be a hard inquiry. Remember, this is not the end of the world, but it is why experts suggest that you do not try to buy a car shortly after you get a mortgage or two other loan inducing life events in the same year. Acquiring a car loan will trigger a hard inquiry and will show up as new credit.
- Credit Mix: Credit mix is exactly what you think it is- all the different kinds of debt that make up what you borrow. Car loans, mortgages, school loans are some examples of fixed debts. Credit cards and home equity lines of credit are some examples of revolving. Car loans fall into the fixed debt category because the debt disappears as you pay it off. Taking out a car loan will not be a detriment to your credit mix unless you have a sparse credit history with little variety. Optimal credit mix would show credit bureaus that you can manage several different types of debt and manage to pay them in a timely manner.
- Credit Utilization: Credit Utilization is the portion of revolving credit available to you that you are using. Revolving credit is credit like what you are offered through credit cards and home-equity lines of credit. In other words, you can change the amount you borrow easily at any time. The credit utilization portion of your credit score is calculated by finding the % total of your credit used at any time. Experts recommend that you stay below 30% credit utilization for the most positive credit score impact. Since a car loan is a finite amount that you will make predetermined payments toward for a pre-agreed amount of time, car loans DO NOT impact your credit utilization.
- Payment History: If you have a history of missing payments, you could end up with a higher interest rate and stricter loan repayment terms on your new car loan. Simply taking a car loan will not impact your payment history on your credit score. However, as you make payments in a timely fashion on your car loan, this could really work in your favor. As you pay down your debts on time, your credit report’s payment history portion will improve. So, taking a car loan could work to increase your credit score overall.
If you are feeling undeterred by the credit impact of taking out a car loan and are ready to move forward, here are a few things to consider:
4 tips for Shopping for a Car Loan:
- Review Your Credit Score: Knowing your credit score before you apply for a car loan can certainly help you know what to expect and if the terms and conditions offered to you are consistent with your credit score.
- Shop Around for the Best Rate: Your first offer is not always your best offer. Credit Bureaus consider hard inquiries made during a 14–45-day period to be one single hard inquiry because they know consumers will want to shop around. If you know your credit score going into loan applications, you will be better able to negotiate for the terms and conditions that are agreeable to you. In addition to applying with your car dealership, you might also check your bank or credit union for offers because they sometimes payback loyalty with decreased interest rates or more lenient repayment timeframes.
- Do Not Overspend: You should know what your budget allows before you ever step foot in a car dealership, and that does not always mean spending up to what you are approved for! Car dealerships are in the business of making money, and you should be firm in your budget. Just because you can get a loan for a $60,000 car does not mean that your budget actual supports the payments on a $60,000 car. Having a list of non-negotiables and negotiables before you go to buy can save you a lot of money in the end. Just because the super tinted windows give off boss vibes doesn’t mean you have to have them.
- Set-up Automatic Payments: Lenders want to know they are going to get their money, bottom line. They will often offer their buyers incentives that reduce interest rates, extend repayment periods, reduce down payments, etc., for buyers willing to sign up for automatic payments. This is a win-win. You know you will always have your payments made on time, and they know they are getting paid, and lots of times, they will reward you for doing so!
Bottom Line: How Much Will a Car Loan Drop My Credit Score?
Unless you plan on throwing down a wad of Benjamins to pay for your new car, car loans are a necessary part of the process.
They will be a temporary blip on the credit report radar and as long as you are not taking out multiple loans in one year and are consistent and dedicated to repaying your loans on time.
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