If you are shopping around for a new or used car, you may be wondering how auto loans affect your credit score. Like many questions of this sort, the answer is – it depends on your choices.

Automotive financing (both leases and loans) affects your ratings just like any other type of borrowing relationship. You can wind up improving your standing, or ruin it.

Car loans can help you build your credit score by diversifying your account mix, and by establishing a history of on-time payments. You first have to overcome a temporary dip that occurs at the beginning of the process.

After the initial dip, the rest depends on you. If you make your payments on time, you are golden. On the other hand, a history of late payments or repossession can really hurt.

When Auto Loans Build Your Credit Score

Like almost any other form of borrowing, auto loans can build your credit score over time when managed responsibly. You may experience a temporary dip in your ratings (see below). However, most consumers will find that by diversifying the account types in use and making payments on time every month, their ratings will gradually improve over time.

Help your ratings by choosing a car you can easily afford, or repair your existing vehicle. Make your payments on time, and expect a bump in your ratings if this is your first transaction of this type.

Credit Mix

For young adults and other consumers seeking to establish themselves, taking out an auto loan can improve your credit rating by diversifying the types of accounts in use. The mixture of account types in use makes up 10% of the rating for an average consumer.

The equations can make projections about future payment performance more confidently when they can draw upon experience that is more diverse. An auto loan is a secured, installment contract. Having this type of borrowing activity on your consumer report helps you check off one of the four main quadrants.

  • Home equity line of credit
  • Car finance
  • Mortgage
  • Credit card
  • Personal loan

“Secured,” means that you pledge collateral in order to obtain the loan. The bank holds the title to your car until you retire the debt. “Installment,” means that you have fixed monthly payments for a specified number of periods. It is a closed contract.

Unsecured contracts rely on your signature alone and are a poor choice for financing a car – unless you need a larger down payment, or fear the loss of the vehicle to repossession.

Positive Payment History

Making car payments on time every month for the entire term of the loan builds a positive history. Most auto finance companies report positive payment history to all three of the consumer bureaus. The equations utilize these data to make its predictions.

This positive history increases your credit score over time. Payment history makes up 35% of the ratings for the average consumer. If you have been late on other obligations, the best way to overcome this problem is to balance out the negative with positive behaviors.

When Auto Loans Hurt Your Credit Score

Like most other forms of borrowing, auto loans and leases temporarily hurt your credit score at the beginning. This step backward is relatively small and short-lived – provided you make your payments on time every month.

However, if you fall behind on payments you will harm your ratings for up to seven years. Worse yet, if you needed a cosigner, you degrade that person’s score for up to seven years as well.

Inquiries and Applications

Auto loan inquiries, applications, and approvals all temporarily hurt your credit score by a little. If you need a reliable vehicle to commute to work, do not allow this momentary dip stop you from shopping around for the best deal. Just be aware that the buying process influences two significant factors in your rating.

  1. New borrowing activity makes up 10% of the average consumer’s rating.
    1. Auto loan inquiries signal a new relationship may open shortly.
    2. The equations ignore shopping inquiries bunched together in a short period.
    3. Most inquiries appear on only one bureau report.
    4. Applications often trigger inquiries.
  2. The length of history makes up 15% of the rating for the average consumer.
    1. Approvals mean a new account appears on your report.
    2. Most lenders report the new account to all three bureaus.
    3. New accounts shorten the average length of history.

Late Car Payments

Very late car payments hurt the credit score of the primary borrower and the cosigner (if applicable) for up to seven years. As mentioned above, payment history makes up 35% of the ratings for the average consumer. You want to avoid negative payment history at all costs. However, not every late car payment affects your consumer report and score equally.

  • Less than 30 days late
    • Pay a late fee
    • Does not appear on consumer report
    • Does not affect your credit score
  • 30 days late or worse now
    • Appears on consumer report
    • Hurts credit score most while delinquent
    • Degree of lateness harms ratings more
  • 30 days late or worse in the past
    • Ratings improve when you bring the account to current
    • Impact on score declines over time
    • Negative history ages from file 7 years after date of first delinquency

Borrowers with high debt-to-income ratios are most likely to fall behind on payments. Keep this in mind as you consider how much to spend. Pick the option with the lowest sticker price to avoid this trouble.

Repossession of your car severely hurts the credit report and score of both the borrower and cosigner. Lenders will repossess vehicles when they determine that you are unlikely to return to on-time payment status. Once they repossess your car, your opportunity to make amends is gone. The repossession will be the final status of the account and will remain on your report until its scheduled expiration – 7 years after the date of first delinquency.

As you can see, you are in control of whether an auto loan helps or hurts your credit score. Make your payments on time to build a positive history, and enjoy lower interest rates on your next big purchase.