How Does a Car Loan Application Affect Your Credit Score?

car loan

Your credit score is a numerical expression that represents your creditworthiness. It’s based on an analysis of your credit files. Your credit files are generally compiled by credit bureaus and reflect the loans you’ve taken out, including credit cards and your payment history.

The amount of debt you’re carrying and the reliability with which you make loan payments will determine your credit score. Other factors that are also considered are the amount of available credit you use, the length of your credit history, how often you establish new credit, and whether you manage different kinds of credit.

These factors are weighted by FICO as follows:

  • 35% of your credit score is based on your payment history, especially whether you make on-time payments
  • 30% of your credit score is based on credit utilization. This measures how much of your available credit you use. Ideally, you should use between 5 and 30%.
  • 15% of your credit score is based on the length of your credit history. Usually, the longer you have an established credit history of on-time payments, the better your score.
  • 10% of your credit score is based on establishing new credit.
  • 10% of your credit score is based on whether you manage different kinds of credit like a mortgage and a line of credit.

What happens to your credit score when you apply for a car loan?

When you apply for a car loan with a lender like LendingArch, they will perform a hard pull on your credit. This means that a creditor has asked to look at your credit file to determine whether you pose a risk as a borrower. A single hard inquiry will usually drop your credit score by a few points. However, the overall impact will be small. Furthermore, if you have multiple hard pulls from various auto lenders, they will be rolled into a single inquiry as long as they are done within a 14-day timeframe.

A hard inquiry will affect your credit score for up to 12 months. However, it will stay on your report for two years.

What happens to your credit score if you take out a car loan?

If your application is accepted and you end up taking a car loan, this will impact your credit score. For starters, it will increase your debt load and change your credit utilization ratio. This may cause a slight drop in your score. Any slight decline in your credit score should be fixed quickly. This can be done by making your first few payments on time. After all, as we saw in the outline above, payment history is the biggest factor in your credit score. That being said, a car loan will improve your credit mix. Having a diverse credit portfolio will show that you successfully manage different types of credit, and this appeals to lenders.

What happens to your credit score when you pay off your car loan?

Paying down the balance of your auto loan over time will cause your credit utilization to go down. As a result, your credit score may improve. Furthermore, if you’ve been making regular on-time payments, your payment history will be good and also positively affect your score.

If you want to pay off your loan early, make sure your loan agreement doesn’t include penalties for doing so. Also, it’s important to remember that having a properly managed, open line of credit establishes a strong history, which is good for your credit score.

Conclusion

A car loan application can briefly cause your credit score to drop slightly because lenders will perform a hard inquiry. However, if your application is accepted, the loan itself will positively impact your credit score so long as you make your payments on-time. Therefore, even though you will initially experience a drop in your credit score, in the long run, it will be improved.

The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.