Can a Car Loan Build Credit and Raise My Credit Score?

Ben Allen
Does a Car Loan Build Credit? How Many Points Will it Raise My Credit Score?

Building your credit should be a long-term, personal goal. Credit plays a big part in most people’s day-to-day life. A high credit score can get you:

  • Lower interest rates on loans;
  • Easier approval on rentals;
  • Higher limits on credit cards;
  • More negotiating power;
  • Avoid security deposits.

It’s important to know and keep track of your credit score so you can ensure you are taking the right financial steps. If you’re unsure what your credit score is, there are free credit resources that can help you obtain that information. 

A good way to build your credit is to get a loan and pay it off. Since many people cannot pay out of pocket for a new car, they opt for an auto loan. Done correctly, auto loans can help build your credit in the long term. 

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Does a Car Loan Build Credit?

Having a loan itself doesn’t help build your credit. In fact, the loan will lower your credit score initially because you’ve taken on extra debt. It’s not ideal to take out multiple loans at the same time because, each time, your credit score will likely drop.

What builds your credit is regularly making payments on your car loan. Each time you make a payment, your lender reports back to credit bureaus. That payment information goes on your credit report as positive activity, which raises your score. Long-term, on-time payments will help keep your credit score in a positive range.

How Many Points Will a Car Loan Raise My Credit?

Your FICO credit score is determined by several different factors, including: 

  • Your payment history;
  • How much debt you have; 
  • How long you’ve had and used credit. 

The area that’s considered the most important though is your payment history. If you make payments on time, your credit score will grow.

How much your credit score will increase is determined by your starting point. If you already have a credit score in the 800s and you make payments on a car loan, it won’t increase much because the highest score is 850. 

But if you have a low credit score, like in the 400s, making regular and on-time payments can raise your credit score considerably over the long term.

You also need to consider what else affects your credit report. If you make on-time payments on your car loan, but fail to make mortgage payments, your score will likely decrease. 

Negative items impact your credit score more than positive items. If you have a long list of negative items, including missed or late payments, bills going to collections, and declaring bankruptcy, paying off a car loan on time won’t do much for your credit score. 

The best thing for you to do is to get your credit in good standing by disputing any errors, paying off debt, removing any negative items, and building a reputation for paying debts on time. 

Does Paying Car Insurance Improve My Credit?

Like normal monthly bills, paying for car insurance does not improve your credit. You aren’t exercising a kind of credit or loan, so there is no reason to report the payments to credit bureaus. 

However, if you fail to pay your car insurance bill long enough, that bill could be turned over to a collections agency and listed as a “delinquent” payment to the credit bureaus, hurting your credit. Additionally, some car insurance companies base your insurance rate on your credit score, which is another reason to try to improve your credit report. 

However, there is a way to use paying off your car insurance to your benefit: charge it to your credit card. A positive action, like paying off your credit card on time, is reported to the credit bureaus. Be sure that you can pay off your credit card in full and on time, or you risk hurting your credit. 

How Will a Car Loan Affect My Credit?

Having a car loan can impact your credit in a variety of ways. It’s a risk to take out a large loan when the future isn’t always clear. For instance, if you end up losing your job and can’t pay for the loan, you’ll hurt your credit. However, if you are able to pay the full amount of the loan on time, it can be a major boost.

The initial act of taking out a car loan slightly decreases your credit score. That’s because you are taking on extra debt, and one factor in a FICO credit score is how much debt you have. 

Once you start making payments, your score will bump right back up. If you make all of your payments on time, your credit score increases. The most reliable way to grow your credit is by making on-time payments with every loan and credit card you have.

Missing a Payment on a Car Loan

This is one of the most common negative items on credit reports. Whether you forgot about the payment or didn’t have the money to pay for it, missing a payment will hurt your credit. 

Every time you miss a payment, the delinquency is reported to a credit bureau. Even if you make up the payment later on, it will stay on your credit report as a missed payment for seven years until it is taken off. 

If you missed your payment by a day or so, don’t panic. Most lenders wait around 30 days before reporting a missed payment to the credit bureaus. As long as you reach out to them, tell them the payment is coming, and then actually pay it, your credit score shouldn’t be affected. 

However, you might have to pay a late fee. To avoid missing a payment on your auto loan, you can use an auto lender that has nationwide coverage so you can obtain an affordable auto loan.

Refinancing a Car

Refinancing a car loan won’t impact your credit score as long as you keep up with your monthly payments. When the actual refinancing happens, your old loan is closed out and paid and the new loan is immediately added to your credit report at the same time. 

You’ll want to make sure you’re refinancing your car loan for the right reason. Common instances in which people refinance their car loan include:

  • When interest rates have dropped;
  • When your financial situation has improved and your debt-to-income ratio is lower;
  • When you find better loan terms;
  • When you’re having trouble keeping up with bills each month.

All in all, if refinancing your vehicle loan allows you to meet your monthly payments, it’s a smart credit decision in the long run.

Paying Off a Car Loan

Paying off your car loan early or on time will likely raise your credit score because the car debt is no longer on your report. However, without regular payments, your score won’t continue to grow. 

If you have no other payments, including credit cards or other loans, your credit score stays stagnant. Once you pay off your car loan, make sure there is some activity, such as regularly using and paying off credit cards.

Becoming Delinquent on Your Car Loan

If you miss enough payments, you become delinquent on your car loan. The lender will take extra steps to get their money back, which all negatively impact your credit score. This can include: 

  • Sending your debt to collections;
  • Constant calls to your home and cell phones;
  • Constant negative marks on your credit score for missed payments.

If you become delinquent on your car loan, there are steps you can take to remedy the situation:

  • Submit a dispute to the credit bureaus;
  • Dispute with the business that reported to the credit bureau;
  • Send a pay for delete letter to the the creditor;
  • Send a goodwill letter to request a deletion.

It’s important to note that paying off the delinquent loan will not remove the delinquency from your credit score. However, a paid loan, albeit late, looks better to lenders than an outstanding loan. 

Having a Car Repossessed

If you go too long without making a payment, the lender is allowed to repossess your car as long as it doesn’t “disturb the peace.” A disruption of peace occurs when a repo man uses force to enter a locked building. 

Your car is used as collateral in the loan, meaning that once you stop paying it off, it becomes the property of the lender. Repossession is a huge negative mark on your credit score, with only declaring bankruptcy hurting your credit more. 

If you’ve reached the point of repossession, your credit score may have already taken some heavy hits. However, there are some steps you can take to recover from a repossession:

  • Find out why it was taken and if you can get it back. Sometimes a car is repossessed by mistake.
  • Gather your belongings from inside the car — the repo men do not have a right to hold your personal property.
  • Ask if you still owe money if the car is sold.
  • Work on improving your credit by making on-time payments. 

When a negative item hits your credit score, it can take time to remove that impact. It’s important to remain patient and work on improving your credit score while waiting for the negative mark to fall off your report. 

Before you take on the extra debt of a car loan, make sure you have the money to pay for it. Account for other current debts and bills, including student loans, rent, cell phone bills, and groceries, and create a budget

Avoid assuming you have money because you got pre-approved for the loan; check your finances and make sure you have the money available. Then, make your payments on time and build your credit.

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