Does Taking Out a Car Loan Hurt Your Credit?

A common question for individuals considering a car loan is how it might influence their credit standing. The answer is not a simple yes or no, as the effect on one’s credit score is multifaceted and can evolve over time. Understanding how a car loan interacts with a credit profile helps individuals make informed financial decisions.

The Immediate Impact of Applying

When an individual applies for a car loan, lenders perform a “hard inquiry” or “hard pull” on their credit report to assess creditworthiness. This action is recorded on the credit report and can cause a small, temporary reduction in a credit score. A single hard inquiry might lead to a drop of less than five points in a FICO Score, though the impact can vary.

Hard inquiries remain on a credit report for up to two years, but their influence on credit scores diminishes after 12 months. Multiple inquiries for auto loans within a short timeframe (usually between 14 and 45 days) are often treated as a single inquiry for scoring purposes. This allows individuals to compare loan offers without incurring several score reductions.

Opening a new loan account can also affect the average age of all credit accounts. A longer average age is generally viewed favorably. Adding a new account can lower this average, particularly for those with a limited number of existing credit lines.

This initial decrease is usually minor and temporary, especially if the individual has an established credit history. The “new credit” category, which includes inquiries and newly opened accounts, accounts for about 10% of a FICO Score. While a new account lowers the average age, this factor generally carries less weight than payment history.

How a New Car Loan Affects Your Credit Profile

Once a car loan is approved and active, it influences a credit profile through “credit mix.” This refers to the different types of credit accounts an individual manages, such as revolving credit (like credit cards) and installment loans (like mortgages or car loans). Successfully handling both types of credit demonstrates an ability to manage diverse financial obligations.

Adding an installment loan, such as an auto loan, can positively diversify a credit portfolio, especially if an individual’s credit history has primarily consisted of revolving accounts. This diversification can show a broader experience with credit management. While credit mix is a factor in credit scoring models, it typically accounts for about 10% of a FICO Score, and holds less weight than payment history or credit utilization. It is not advisable to take out loans solely to improve credit mix.

The car loan also impacts the “amounts owed” category, which is a significant factor in credit scoring. While an auto loan adds to an individual’s total debt, it differs from revolving credit in how it affects the “credit utilization ratio.” This ratio, which compares the amount of credit used against the total available credit, primarily applies to revolving accounts like credit cards. Installment loans, by their nature of fixed payments and a set term, do not directly factor into this specific ratio.

The total outstanding balance of the car loan is still considered within the broader “amounts owed” category. This category generally accounts for about 30% of a FICO Score. As payments are made and the loan balance decreases over time, this can reflect positively on the credit profile, assuming all other financial obligations are also managed responsibly.

The Ongoing Impact of Payment Behavior

The most influential factor determining whether a car loan ultimately benefits or harms credit is payment behavior. Payment history accounts for 35% of a FICO Score, making it the largest component. Consistently making car loan payments on time demonstrates financial responsibility and reliability to lenders, which can significantly build a positive credit history over the loan term. This consistent activity gradually improves a credit score.

Conversely, late or missed payments can severely damage a credit score. Creditors typically report payments as late to the major credit bureaus once they are 30 days past the due date. The longer a payment remains outstanding (such as 60, 90, or 120 days late), the more significant the negative impact on the credit score. Each instance of a reported late payment can cause a substantial drop in scores.

A single late payment can remain on a credit report for up to seven years from the original delinquency date. While the impact on the score lessens over time, especially if subsequent payments are made on time, it still serves as a negative mark. Accumulating multiple late payments can lead to a sustained and more severe downturn in credit standing, signaling higher risk to lenders.

The most severe negative consequence of a car loan is defaulting on the agreement. Loan default occurs when an individual fails to make payments as agreed for an extended period, leading to a “charge-off” on the credit report, which signifies that the original creditor has given up on collecting the debt. Since car loans are secured by the vehicle, a default almost invariably results in repossession of the car.

Both the loan default and the repossession are reported to credit bureaus and remain on the credit report for seven years, causing substantial and long-lasting damage to credit scores. Even after repossession, the individual may still be liable for a “deficiency balance” if the sale of the repossessed vehicle does not cover the remaining loan amount and associated fees. Such accounts can be sent to collections, leading to further negative credit reporting and potential legal action.