If your credit score has seen better days, you might be considering a way to diversify it with different types of credit.
A new car loan, for instance, may be top of mind. Perhaps you heard adding an auto loan to your credit portfolio will help increase your credit score.
But how will a car loan increase your credit score? And how quickly can it happen?
Here’s what you’ll learn in this post:
- What is a credit score?
- How to improve your credit score with a car loan
- Can an auto loan improve your credit score?
- How fast does a car loan increase your credit score?
- Does car insurance improve your credit
WHAT IS A CREDIT SCORE?
As you know, your credit score can be used for a variety of things in everyday life: from obtaining a mortgage to credit cards.
Your credit score is a number between 300 and 850, and used by lenders to determine how likely you are to pay back what you’ve borrowed. The higher the number, the better; the higher your score, the more likely you’ll be to acquire a loan or line of credit with lower interest rates.
The most popular credit bureaus include: Experian, Equifax, and TransUnion. Each bureau may have a slightly different score based on their credit scoring model, and each lender has a preferred score (or a mix of all three) that they use to assess creditworthiness.
Your credit score is calculated using a variety of factors — each responsible for a different percentage of the score itself, including:
- Payment History (35%): As the biggest factor in your credit score, your payment history shows how likely you are to repay your debt or the level of risk that you won’t repay your loan.
- Amount Owed (30%): This part of your score is also known as credit utilization or how much of your available credit you are using. It’s recommended to never owe more than 30% of your total credit; but ideally, it’s best not to utilize more than 10% of your total credit.
- Credit History (15%): When you have long-standing accounts, it shows that you have the ability to have successful credit history over a long period. For this reason, it’s generally not recommended to close accounts with long histories as that could decrease your credit score.
- Credit Mix (10%): Having a good mix of different types of credit (mortgage, car loan, credit cards, etc.) shows that you can manage multiple types of accounts, systems, and payment dates.
- New Credit (10%): This final factor tells lenders that some credit is simply too new to assess how creditworthy you are. Your unique credit score depends on how your credit history measures up in all these factors.
HOW TO IMPROVE YOUR CREDIT SCORE WITH A CAR LOAN
Now that you have a better idea of how your score is calculated, one obvious question arises: how do you improve your credit score?
When you take out a car loan, you have an opportunity to improve your credit score by consistently taking the following actions.
Diversify credit mix
When you take out a car loan (and you didn’t have one or haven’t had one for a while), this will improve the credit mix portion of your credit score.
Build a positive payment history
An on-time payment here and there won’t do it; it’s critical to make full payments on time, each and every time. The longer you can do this, the more you’ll see your credit score improve.
Hard inquiries
When you have too many inquiries (or requests for credit or loans), it can be a red flag to lenders. It may mean that you’re applying for multiple loans at once, which can be concerning for proper payments.
However, having an inquiry every once in a while (such as when you apply for your car loan) can be a sign of healthy credit use. At the same time, there is a potential that the inquiry will temporarily take a few points off your credit score.
CAN AN AUTO LOAN IMPROVE YOUR CREDIT SCORE?
So will your car loan help increase your credit score? Yes and no. Car loans take time to affect your credit, so it’s a long-term plan.
Decreasing your credit score can happen quickly with a few mistakes or missed payments, while increasing your credit score can take time. Here’s how that works:
Short-term improvement
In the short-term, your score will likely decrease when you acquire an auto loan (and even refinance).
Not only can the hard inquiry for your credit score decrease your score, but adding a significant amount of debt to your overall credit will likely decrease your score at first as well.
Long-term improvement
The good news is these decreases won’t last forever. In fact, in the long-term, your car loan should help improve your credit score as long as you continue to make full payments on time each month.
Using an auto loan to improve your credit score is a slow, steady plan that will take diligence and consistency.
HOW FAST DOES A CAR LOAN INCREASE YOUR CREDIT SCORE?
With so many factors involved in calculating a credit score, it’s impossible to say how long it will take to see an increase in your credit score.
However, as we mentioned, decreasing your score happens more quickly than increasing it. That means it’s critical to always pay your car loan in full and on time to ensure there are no penalties. Missed or late payments (usually 30 days or more) can cause serious drops in your credit score.
DOES CAR INSURANCE IMPROVE YOUR CREDIT?
Since you’re also paying for auto insurance coverage, you might also be wondering if paying for your car insurance policy will help your credit.
Unfortunately, like any other monthly bills — like utilities or your cell phone — there is no effect on your credit.
That said, if you fail to pay your insurance balance for a certain period, your carrier could report the bill to a collections agency. Failure to pay could then be reported to the credit bureaus and ultimately harm your credit.
Additionally, some carriers will base your car insurance rates on your credit score, so it’s beneficial to work hard to increase your score.
There’s a lot to consider when it comes to improving your credit score. While a car loan paid on-time will ultimately help increase your credit score, it’s a long-term plan that needs your full commitment.
If you need help finding the best auto insurance coverage for the best price, start by speaking to a SimplyIOA agent at 833.872.4467 or get an auto insurance quote online now.
