How An Auto Loan Can Help You Rebuild Credit
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Your credit score plays a key role in your financial life. A good score can open many doors in terms of financing, but a bad score can do the total opposite. Maintaining a good credit score is something you should aim for to ensure a healthy financial profile, and an auto loan may be able to help you do that.
The question is, how exactly can an auto loan influence your credit score?
How Can a Car Loan Help Me Rebuild Credit?
Before we get into how a car loan can help you get your credit score back up to where it should be, it’s important to understand exactly what makes up your credit score:
- Payment history – By far, your payment history has the biggest impact on your credit score. More specifically, payment history makes up 35% of your score. That means a history of missed payments will have a bigger impact on your credit score compared to any other factor. If you’ve had a habit of not making your bill payments on time, your credit score can take a big hit. On the other hand, a history of timely payments can be very good for your credit score.
- Debt load – A close second to your payment history is your debt load and credit utilization. More specifically, the amount of debt that you carry relative to your income matters a lot when it comes to your credit score. So does the amount of credit that you use relative to how much you are allowed. This accounts for 30% of your credit score. If you max out your credit, your credit score can suffer.
- Length of credit history – The length of time you’ve been a credit user or have had a certain credit account open has a weight of 15% on your credit score. Though not as much weight is given to this compared to payment history or debt load, it still matters. Generally speaking, the longer these accounts are active, the better for your credit score.
- Credit mix – Making up 10% of your credit score is credit mix, which refers to the types of accounts that are on your credit report. These can include credit cards, car loans, student loans, and mortgages.
- New credit – Having your credit checked to open a new account can pull your credit score down, albeit temporarily, and also makes up 10% of your credit score.
A car loan can have both a positive and negative effect on your credit score based on the criteria mentioned above. When you apply for a car loan, your score may be pulled down slightly because you’re taking out new credit. When a lender pulls your credit report after you apply for a loan, this is what’s known as a “hard inquiry” and can have a negative impact on your credit score, though only temporarily.
However, once you have been approved for a car loan, timely payments that you make can be a very good thing for your credit score. Further, adding to the mix of credit on your report can also be a good thing for your overall score. That said, missing car payments can pull your credit rating down, so it’s essential that you are responsible with your car payments after securing a loan to finance a vehicle purchase.
How to Use a Car Loan to Rebuild Credit
If your credit score is already in the dumps, a car loan may be able to help you rebuild your credit, as long as you adopt certain habits and ditch others.
As mentioned before, your payment history makes up 35% of your credit score. If you consistently pay your car loan bills every billing cycle without fail, this can have a positive effect on your score. On the other hand, if you struggle to repay your auto loan, your credit score will suffer.
The key is to make sure that you take out a car loan amount that your current finances are able to comfortably handle. You don’t want to take out a loan so high that you will barely be able to cover payments. Keeping up with bill payments is key, so taking out an auto loan that is within your financial means is very important to rebuilding credit.
Again, adding another loan account to your credit report in the form of a car loan can also positively impact your credit mix, which plays a role in your overall credit rating. Ideally, you want to have a mix of different credit on your credit report, including installment loans like car loans, as well as revolving debt like credit cards.
Benefits of Using a Car Loan to Rebuild Credit
Using a car loan to rebuild your credit comes with certain perks. Of course, the biggest benefit is rebuilding and increasing your credit score. With every timely payment that you make, you’re inching your credit score back up to where it could and should be.
In addition, you can take advantage of a couple of other benefits:
Refinance at a lower rate when your score improves. With a low credit score, you may have trouble getting approved for a loan. But even if you do, you will likely be offered a higher interest rate on the loan than you would with a higher credit score. However, if you’ve been diligent about repaying your car loan, your credit score can see a major boost after a few months, after which you may be able to refinance at a much lower rate and save a bundle.
Improve your odds of securing other loans. Not only will a higher credit score make it easier to get approved for a car loan, but it can also open up the doors to other loan products too. Mortgages, personal loans, and credit cards will be much easier to secure with a higher credit score, which you can build by being diligent with your car loan payments.
Drawbacks of Using a Car Loan to Rebuild Credit
While there are certainly some advantages to using a car loan to rebuild credit, there are some cons that you should be aware of:
Repossession risk. When you take out a car loan, your new vehicle is being used as collateral to secure the loan. That means if you default on your loan payments, the lender could repossess the car in an effort to recoup their losses. That means not only will your credit score suffer, but you’ll be without a car, too.
High-interest rates. If you have a low credit score, the interest rate you will be offered will likely be pretty high. In turn, this can make your car loan very expensive. You’ll be paying a lot more toward interest than you need to be.
Money is tied up. By taking out a car loan, you’ll be dedicating more of your income toward this new debt, leaving less money leftover for other expenditures.
Rebuilding Credit with a Car Title Loan
Up to now, we’ve been talking about rebuilding your credit using a car loan. But what about a car title loan?
A car title loan is a type of financing that provides you with the cash you need in a lump sum in exchange for the title of your car. In this case, the title of your vehicle – or ownership – is being used as collateral to secure the loan. With this arrangement, you would surrender the title of your loan and put a lien on it until you repay the full amount of the loan to the lender.
There are certain perks to car title loans:
Credit checks are often not required. Some lenders don’t run credit checks for car title loans. This can be good news for borrowers with a bad credit score, who may otherwise be unable to get approved for a traditional loan.
Car serves as collateral. Car title loans are relatively easy to get approved for because they are secured loans that use the vehicle itself as collateral. As such, you won’t have to come up with any other collateral to secure this type of loan.
Quick access to cash. Car title loans usually don’t take too long to process, meaning you can get your hands on the money you need quickly, which can come in handy when you have a financial emergency to meet.
Help improve your credit. If you are diligent with your loan payments, a car title loan can help you rebuild your credit.
Consolidate your debts. The funds you receive from a car title loan may be used to consolidate your debts. This makes sense if you have many high-interest debts on the books, and the rate that you are given with a car title loan is lower. At the end of the day, this can help you save money and make managing bill payments easier.
Not only can an auto loan help you purchase a car without having to come up with the price tag in full, but it can also offer you an opportunity to rebuild your credit score. If your score is currently lagging, you’ll want to take steps to give it a boost, and being responsible with your car loan payments is a great way to do just that.
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