Does Paying a Car Loan Help Credit?
Discover how managing a car loan impacts your credit score, affecting your financial health in various ways.
Credit scores are numerical representations of an individual’s creditworthiness, used by lenders, landlords, and other financial institutions to assess the risk associated with extending credit or services. Various financial activities, including the management of loans, contribute to the calculation of these scores. Understanding how these scores are determined can help individuals make informed decisions about their financial health.
Payment History
Payment history is the most significant factor influencing credit scores, accounting for approximately 35% of a FICO Score and being “extremely influential” for VantageScore models. Consistently making on-time payments on a car loan demonstrates financial responsibility and builds a positive credit record. This consistent behavior signals to potential creditors that an individual is likely to repay new debts as agreed.
Conversely, late or missed payments can severely impact a credit score. A payment needs to be 30 days or more overdue before it is reported to the credit bureaus, but even a single late payment can cause a notable drop in scores. The negative effect of missed payments can become more pronounced the further behind an individual falls. Such delinquencies remain on a credit report, though their impact diminishes over time. Paying a car loan consistently and on time is therefore a direct and effective way to strengthen one’s credit profile.
Credit Mix and Account Types
Credit mix refers to the variety of credit accounts an individual manages, contributing about 10% to a FICO Score. This factor assesses a consumer’s ability to handle different types of debt responsibly. Credit accounts generally fall into two categories: revolving credit and installment credit. Revolving credit, like credit cards, allows for continuous borrowing up to a limit, with payments fluctuating based on the outstanding balance.
Installment credit, such as a car loan, involves borrowing a fixed sum of money that is repaid through scheduled, regular payments over a set period. Having a diverse portfolio that includes both revolving and installment accounts can positively influence a credit score. For individuals who primarily use credit cards, adding an installment loan like a car loan can broaden their credit profile, showcasing a more comprehensive financial management capability.
Length of Credit History and New Accounts
The length of one’s credit history is another factor in credit scoring, accounting for about 15% of a FICO Score. A longer history of successfully managing credit accounts is seen as a positive indicator of financial responsibility. This factor considers the age of the oldest account, the newest account, and the average age of all accounts.
When a new car loan is opened, it can initially reduce the average age of accounts on a credit report. Additionally, applying for a new loan results in a “hard inquiry” on the credit report, which can cause a temporary, small dip in the credit score. Hard inquiries remain on a credit report, though their impact lessens over time. However, over time, as payments are made consistently on the car loan, it matures and contributes positively to the overall length and stability of the credit history, outweighing the initial minor impact.
Amounts Owed and Overall Debt
The amounts owed on credit accounts contribute significantly to a credit score, making up about 30% of a FICO Score. While “credit utilization” primarily applies to revolving credit and measures the percentage of available credit being used, the total amount of debt an individual carries is also considered. A car loan, as an installment loan, adds to the total outstanding debt. Lenders assess how much of the original loan amount is still owed, and paying down installment loans can be viewed as a positive sign of debt management.
Although a car loan has a fixed payment schedule, the overall debt burden influences a lender’s perception of creditworthiness. Lenders also consider an individual’s debt-to-income (DTI) ratio, which compares monthly debt payments to gross monthly income. A lower DTI ratio indicates a better balance between income and debt, making an individual a more attractive candidate for new credit. While DTI does not directly impact the credit score itself, it is a separate metric lenders use to evaluate the capacity to take on and manage additional debt, indirectly influencing access to future credit.