Does Paying a Car Loan Build Credit?
Discover the nuanced ways a car loan contributes to your credit profile. Understand its role in building and maintaining a healthy credit score.
A credit score is a numerical representation of an individual’s creditworthiness, a three-digit number lenders use to assess risk. It influences securing loans, renting property, and obtaining insurance. Understanding how financial activities, like managing a car loan, impact this score is valuable for financial health.
The Direct Link: Car Loans and Your Credit Score
Paying a car loan can directly contribute to building a positive credit history. A car loan is a type of installment credit, meaning a fixed amount is borrowed and repaid in regular, set payments over a predetermined period. This differs from revolving credit, like credit cards, where the amount owed can fluctuate.
The most significant factor in building a positive credit score through a car loan is consistent, on-time payments. Each on-time payment is reported to the three major credit bureaus (Equifax, Experian, and TransUnion). These reports contribute to your payment history, the most influential factor in credit scoring models. Consistent on-time payments significantly improve your credit score.
Conversely, missed or late payments severely damage a credit score. A payment 30 days or more past due negatively impacts your credit and can remain on your report for up to seven years. Even a single late payment can decrease your score, signaling higher risk to lenders.
Beyond Payments: Other Car Loan Factors Affecting Credit
Beyond the direct impact of payment history, a car loan influences a credit score through other mechanisms. Adding an installment loan, such as a car loan, to a credit profile can diversify a borrower’s credit mix. Credit scoring models consider the variety of credit types an individual manages, with a healthy mix often including both revolving accounts and installment accounts. This diversification can positively affect the credit mix component of a score, demonstrating the ability to manage different forms of debt responsibly.
Applying for a car loan typically results in a “hard inquiry” on a credit report. A hard inquiry occurs when a lender checks an applicant’s credit history to make a lending decision. This action can cause a slight, temporary dip in a credit score, often by a few points. The impact is usually minimal and brief, affecting the score for only a few months, though the inquiry may remain on the report for up to two years.
If an individual applies for multiple car loans within a short timeframe, typically within a 14 to 45-day window, credit scoring models often treat these as a single inquiry. This “rate shopping” grace period allows consumers to compare loan offers without their score being penalized for each separate application. Successfully managing the car loan with on-time payments can quickly offset any temporary decrease from an inquiry.
Understanding Your Credit Score Components
Credit scores are complex calculations based on various pieces of information within a credit report, grouped into several categories. Payment history is the most influential factor, accounting for approximately 35% of a FICO score and being “extremely influential” for a VantageScore.
Amounts owed, also known as credit utilization, is another significant component, making up about 30% of a FICO score and being “highly influential” for a VantageScore. This factor primarily relates to revolving credit and measures the percentage of available credit currently being used. Keeping credit card balances low, ideally below 30% of the credit limit, is generally recommended to positively influence this component. While installment loans like car loans are not typically included in the credit utilization ratio, the total debt load is still considered.
The length of credit history accounts for about 15% of a FICO score and is a “highly influential” factor for a VantageScore. This considers the age of the oldest account, the newest account, and the average age of all accounts. A longer credit history with well-managed accounts generally indicates more experience with credit, which can be seen favorably by lenders. A car loan contributes to the overall age of accounts as long as it remains on the credit report, which can be up to 10 years after being paid off.
New credit, including recent applications and newly opened accounts, makes up about 10% of a FICO score and is “less influential” for a VantageScore. Opening multiple new accounts in a short period can signal higher risk to lenders. Finally, credit mix contributes around 10% to a FICO score and is “highly influential” for a VantageScore.
Monitoring and Improving Your Credit
Regularly checking credit reports is a fundamental step in monitoring and improving credit health. Consumers can obtain a free copy of their credit report every 12 months from each of the three major credit bureaus (Equifax, Experian, and TransUnion) at AnnualCreditReport.com. Review these reports for accuracy and to identify any errors.
Beyond credit reports, monitoring credit scores provides a quick gauge of credit health. Many credit card companies, banks, and free online services offer access to credit scores, often updated monthly. While different scoring models exist, consistently monitoring one or two scores can help track progress over time. These scores do not typically include all the detailed information found in a full credit report but offer a general indication of standing.
To maintain and improve a healthy credit score, especially with an active car loan, several actionable steps can be taken. Setting up automatic payments for all bills, including the car loan, helps ensure on-time payments. Avoiding taking on too much new debt and keeping credit card balances low, ideally below 30% of the available credit limit, also positively influences scores. These practices contribute to a strong financial profile and help in the ongoing process of credit building.