Do Car Payments Affect Your Credit Score?
Understand how your car payments shape your credit score, building good history or risking damage to your financial standing.
A credit score is a numerical representation of an individual’s creditworthiness, essentially a snapshot of their financial reliability. It is a three-digit number, typically ranging from 300 to 850, that lenders use to assess the risk associated with extending credit. This score plays a significant role in various financial aspects of life, influencing approvals for loans, credit cards, mortgages, and even rental applications or insurance rates. Understanding how different financial activities impact this score is crucial for managing one’s financial health effectively.
How Car Payments Build Credit
Consistently making car payments on time demonstrates a borrower’s reliability and commitment to financial obligations. Lenders report payment activity to the three major credit bureaus—Experian, Equifax, and TransUnion—which then update an individual’s credit report. Positive payment history is the most influential factor in credit scoring models. Each on-time payment reinforces a pattern of responsible credit behavior, gradually improving the credit score.
A car loan is considered an installment loan, which means it involves a fixed payment schedule over a set period. Including an installment loan in a credit profile can enhance one’s credit mix. A diversified credit portfolio, featuring both revolving credit like credit cards and installment loans, indicates an ability to manage different types of debt responsibly. Successfully paying off an installment loan over its full term further demonstrates financial discipline and can positively impact the credit score.
The Impact of Missed Car Payments
Failing to make car payments as agreed can severely damage a credit score. Late payments are generally reported to credit bureaus once they are 30 days or more past due. The longer a payment remains overdue, the greater the negative impact on the credit score, with 60 and 90-day late marks causing progressively more significant drops. These negative marks can remain on a credit report for up to seven years from the original delinquency date.
If payments cease entirely, the loan can go into default, leading to repossession of the vehicle. A repossession is a serious negative event that remains on a credit report for seven years from the date of the first missed payment that led to the repossession. This derogatory mark signals a high risk to future lenders, making it difficult to obtain new credit and often resulting in higher interest rates if approved. Should the repossessed vehicle sell for less than the outstanding loan balance, the remaining debt, known as a deficiency balance, can be sent to collections. A collection account can also stay on a credit report for seven years from the original delinquency date and significantly harms creditworthiness.
Key Credit Score Factors Related to Car Loans
Payment history accounts for about 35% of a FICO Score. Consistent, on-time car payments contribute to a positive history, while missed payments negatively impact it.
The amount owed on a car loan also influences a credit score, making up 30% of a FICO Score. While installment loans like car loans do not have a utilization ratio in the same way revolving credit does, a high outstanding balance still represents a significant debt burden. Managing this debt through regular payments reduces the balance, which can be viewed favorably by scoring models.
The length of credit history contributes 15% to a FICO Score. A car loan adds to the average age of accounts and the overall duration of one’s credit relationships.
New credit, which includes hard inquiries and newly opened accounts, accounts for 10% of a FICO Score. When applying for a car loan, a hard inquiry is placed on the credit report, which can cause a small, temporary dip in the score, typically lasting for up to a year. While the inquiry remains on the report for two years, its impact diminishes quickly.
A car loan contributes to the credit mix, a category that makes up 10% of a FICO Score. Having a variety of credit types, such as both installment loans and revolving credit accounts like credit cards, demonstrates an individual’s ability to handle different financial products responsibly.