Does Trading In a Car Affect Your Credit?

Acquiring a vehicle, especially through financing, introduces new factors that interact with an individual’s credit history. Understanding these interactions is important when considering a car trade-in. The process involves multiple financial components, each capable of influencing a credit score.

How Trade-In Value Influences New Financing

When trading in a vehicle, its value directly impacts the financing for a new car. If the trade-in value exceeds the amount still owed on the existing car loan, this creates positive equity. This positive equity can be applied towards the down payment of the new vehicle, reducing the total amount needing to be financed. A smaller loan amount generally results in lower monthly payments and less interest paid over the loan term.

Conversely, negative equity occurs when the amount owed on the current car loan is greater than the vehicle’s trade-in value. For instance, if a car is valued at $12,000 but has a loan balance of $15,000, there is $3,000 in negative equity.

When negative equity exists, dealers may offer to “roll over” this deficit into the new car loan. This means the outstanding balance from the old loan is added to the principal of the new loan, increasing the total amount financed. This can simplify the transaction by avoiding an out-of-pocket payment for the negative equity, but it results in a larger new loan and potentially higher monthly payments and total interest costs. Over one in four new vehicle trade-ins have negative equity, with the average amount owed being thousands of dollars.

Impact of New Car Financing on Your Credit Score

Securing new car financing can directly influence a credit score. When applying for a new loan, lenders perform a “hard inquiry” on a credit report to assess creditworthiness. Each hard inquiry can cause a temporary, slight decrease in a credit score, though its effect is typically short-lived. Credit scoring models often treat multiple inquiries for auto loans within a short period, such as 14 to 45 days, as a single inquiry to minimize impact during rate shopping.

Opening a new credit account, like a car loan, affects the average age of accounts and credit mix. A new account can slightly reduce the average age of all credit accounts, which may cause a minor score adjustment. However, an auto loan can positively diversify a credit mix by adding an installment loan, especially if an individual primarily has revolving credit. Consistently making on-time payments on the new car loan demonstrates financial responsibility and can steadily improve a credit score over time.

The amount of debt incurred with the new car loan also plays a role. Lenders evaluate a borrower’s debt-to-income (DTI) ratio, which compares monthly debt payments to gross monthly income. A higher debt load, especially relative to income, can affect a credit score and a borrower’s ability to secure additional credit.

Impact of Your Previous Car Loan on Your Credit Score

When a vehicle is traded in, the dealership typically handles the payoff of the existing car loan. The trade-in value is applied, and the dealership remits the remaining balance to the original lender, effectively closing the old loan account. This process ensures the previous loan is settled, transferring the vehicle’s title to the dealership.

A closed account with a history of on-time payments remains on a credit report for an extended period, often up to 10 years. This continued presence is beneficial because it contributes positively to the length of credit history and demonstrates responsible borrowing. This positive payment history continues to support an individual’s credit standing even after the account is closed.

Conversely, if the previous car loan had a history of late or missed payments, these negative marks remain on the credit report for up to seven years from the date of the delinquency, regardless of the account’s closure. While their impact may diminish over time, such negative entries can continue to affect the credit score. Paying off an installment loan, even one with a perfect payment history, can sometimes cause a temporary, minor dip in a credit score. This can occur due to changes in the credit mix or average age of accounts, particularly if it was the only installment loan or one of the oldest accounts.