Do Car Payments Build Credit? Here’s What to Know

Car payments influence an individual’s credit standing. Understanding how these payments interact with your credit profile is important for managing financial health. A car loan, when handled responsibly, can build and strengthen credit over time.

Understanding Your Credit Profile

Your credit profile is a record of your financial reliability, summarized by a credit score and detailed in a credit report. A credit score, ranging from 300 to 850, is a three-digit number that predicts your likelihood of repaying borrowed money. FICO and VantageScore are generated from your credit report.

A credit report, compiled by major consumer reporting agencies, details your borrowing and repayment activities. It includes personal identification, credit accounts, public records like bankruptcies, and inquiries from lenders. Each account shows the type of credit, opening date, credit limit or loan amount, current balance, and payment history.

How Car Payments Impact Your Credit Score

Making consistent, on-time car payments is a key way an auto loan can positively affect your credit score. Payment history is the most influential factor in credit scoring models, accounting for about 35% of a FICO score. Regularly meeting payment obligations demonstrates financial responsibility and contributes to a strong credit history.

Conversely, late or missed car payments can damage your credit score. A payment reported 30 days or more past its due date can lower your score, with the negative mark remaining on your credit report for up to seven years. Such delinquencies suggest a higher risk to lenders and can lead to additional fees or, in more severe cases, vehicle repossession. Fees may still apply immediately after the due date, even if a grace period exists before a late payment is reported.

An auto loan is an installment loan, with a fixed monthly payment over a set period. Having a mix of different credit types, such as installment loans and revolving accounts like credit cards, can positively influence your credit score. This “credit mix” demonstrates your ability to manage various financial obligations and accounts for about 10% of your FICO score. When a car loan is fully paid off, the positive payment history remains on your credit report for up to 10 years.

However, closing the account might cause a temporary dip in your score, especially if it was your only active installment loan, as it can affect your credit mix or the average age of your accounts. This dip is short-lived, with scores rebounding within a few months.

Other Loan-Related Credit Factors

Applying for an auto loan involves a “hard inquiry” on your credit report, which occurs when a lender assesses your creditworthiness. A hard inquiry can cause a temporary, minor drop in your credit score, by a few points, generally 5 to 10 points. These inquiries remain on your credit report for up to two years, though their impact diminishes within the first 12 months.

When shopping for an auto loan, applying with multiple lenders within a concentrated period, generally 14 to 45 days, is treated as a single inquiry by credit scoring models. This allows consumers to compare loan offers and interest rates without multiple hard inquiries negatively impacting their score. However, applying for different types of credit, such as a car loan and a credit card, results in separate inquiries.

The initial loan amount and the length of the loan term affect your financial standing. While auto loans do not directly impact credit utilization like revolving credit, the total debt from a car loan contributes to your overall debt-to-income ratio, which lenders consider. Longer loan terms, such as 72 or 84 months, can result in lower monthly payments but lead to paying more in interest over the loan’s life. A higher credit score qualifies you for a lower interest rate, reducing the total cost of the loan.

Preparing for an Auto Loan

Before seeking an auto loan, review your credit score and credit report. Checking your own credit is a “soft inquiry” and does not negatively impact your score. This allows you to identify any errors or inaccuracies that could be disputed and removed, potentially improving your credit standing. Understanding your current credit score provides an indication of the interest rates and loan terms you might expect.

Understand the terms of any loan, including the interest rate and the annual percentage rate (APR), which includes interest and additional fees. Comparing APRs from different lenders provides a clearer picture of the total cost of borrowing. Securing an affordable loan with manageable monthly payments is important, as consistent on-time payments are key to building positive credit. A larger down payment can also reduce the loan amount, leading to a lower interest rate and less risk for the lender.