When you apply for a car loan, your credit score could take a temporary hit. After all, every time a lender runs a credit check with a hard inquiry, it will lower your credit score for a brief period of time. However, by paying your auto loan on time and not skipping payments, your credit score can improve and eventually strengthen your credit history.
Key Takeaways
- Hard inquiries can temporarily lower your credit score, generally five points or less.
- Creditors view hard inquiries as a sign of risk because it indicates you need money.
- A new car loan could add another type of loan to your overall loans, which may benefit your credit score by improving your credit mix.
- In the long term, paying your car payments on time can boost your credit score.
- As you pay down your loan, your credit score can improve as your total amount of debt declines.
How Car Loans Negatively Impact Your Credit Score
When you officially apply for a car loan, lenders will check your credit, which is considered a hard inquiry. This can temporarily reduce your credit score, but generally less than five points.
If you are shopping around with several lenders and each one checks your credit, as long as the inquiries are conducted within 14 to 45 days, they likely will be considered a single inquiry, depending on the credit score model, such as a FICO Score. This can help you avoid a substantial hit to your credit score.
However, if you are applying for multiple forms of credit—like credit cards or a home mortgage—while trying to get a car loan, those credit checks will show up as separate inquiries and could lower your credit score significantly.
Hard Inquiries vs. Soft Inquiries
A hard inquiry shows up on your credit report when a lender checks your credit for a loan, credit card application, or other form of credit. A soft inquiry, such as you may receive for pre-approvals, does not affect your credit score.
How Car Loans Positively Impact Your Credit Score
Paying your car loan can improve your credit score if you make the payments on time and don’t skip any. Making on-time payments accounts for 35% of your credit score, making it the most important factor affecting your credit score.
Likewise, making on-time payments during the length of the car loan could boost other factors affecting your credit score. These include:
- Amounts owed (30%)
- Length of credit history (15%)
- Credit mix (10%)
You may start to see your credit score rise within three to six months if there is no negative activity on your credit report. Your credit score is typically updated monthly.
How Your Auto Loan Affects Your Credit Report
The three credit reporting agencies—Equifax, Experian, and TransUnion—include several factors on your credit report, which can be affected when you take out an auto loan. Specifically, there are three elements you should review in the credit reports: credit inquiries, types of accounts, and credit status. Let’s look at how each factor affects your credit score in more detail.
Credit Inquiries
Credit inquiries can be hard or soft. As previously mentioned, soft inquiries do not impact your credit score, so there’s no need to worry about how many you have on your credit report. Soft inquiries occur in a variety of situations, including when utility companies check your credit to see if they should require a deposit when opening a new account, when credit card companies want to send you pre-qualification offers, when potential landlords run soft credit checks, and more. Hard inquiries, though, do negatively impact your credit score, so it’s worth keeping these to a minimum. In most cases, hard inquiries can remain on your credit report for up to two years.
The good news is that as long as you make on-time payments on your car loan and effectively manage any other credit you have, hard inquiries will not significantly impact your credit score throughout that two-year period. In fact, most credit scoring models stop using hard inquiries as part of the credit score calculation after the first year.
Types of Accounts
The types of accounts you have on your credit report contributes 10% toward your credit score. A varied mix—such as a credit card, installment loan, and mortgage loan—leads to a good credit score. Lenders like to see you can manage different types of credit responsibly; however, it’s not necessary to have every type of account to boost your credit score.
Credit Status
Credit reports will mark an account as “current” or “paid as agreed” if payments are made on time. Payment history is the primary factor in determining your credit score because it shows lenders that you can manage credit responsibly.
For example, if your credit status changes to “30 days late,” this will have a negative impact on your credit score.
Does paying off a car loan early hurt your credit score?
Paying off your car loan early can benefit your credit history because it lowers your “amounts owed,” or the total amount of debt you have. It also reduces the risk that you will make a late payment, which can lower your credit score.
Closing a car loan account could have a potentially negative impact by reducing your credit mix, or the types of loans you have. But the benefits to closing a car loan would outweigh the potential small negative impact to your credit score.
How long does it take for your credit score to go up after you pay off your auto loan?
As long as you maintain a positive credit history, such as making on-time payments for your other credit accounts, your credit score may start to go up within a few months after paying off your auto loan.Your credit score typically updates once a month.
Does an auto loan impact my credit utilization?
An auto loan will not impact your credit utilization rate, which is the proportion of your how much credit you use compared to how much is available to you. An auto loan is not revolving credit like, say, a credit card is. It is considered an installment loan.
The Bottom Line
Although applying for a car loan likely will lower your credit score at first, it can have positive long-term effects if you make your payments reliably. If you are shopping around for a car loan, you can can reduce the number of hard inquiries on your report to just one by applying for the loans within a short period of time.
