How a Car Loan Can Increase Your Credit

car loan increase credit

The following is a guest post from Paige Williams, a public relations specialist with New Roads Auto Loans

The views and opinions expressed in this article are those of the author only and are not endorsed by Credit.com.

When most people think about credit and a car loan, they’re thinking about what credit score qualifies them for the car loan. However, that’s not the only way that a credit score will affect a vehicle loan. Did you know that a car loan is one way to increase your credit score for the better? The following explains how a car loan can increase your credit.

Your New Car Loan Shows up on Your Credit Report

As with any new credit account that you get, your new car loan will show up on your credit report. Depending on the specific credit bureau or bureaus that your vehicle loan lender reports to, it will only show up on those credit reports. There are three different credit bureaus that are mainly used by all lenders: Experian, Equifax, and Transunion.

When you get a new vehicle loan, information for the loan is reported to these lenders. This is crucial in knowing how a new vehicle loan can increase your credit score. All of the following are reported to the credit bureaus of choice from your vehicle lender:

  • Original Loan Amount
  • Type Of Loan (Installment Loan)
  • Monthly Payment
  • Payment History (On-Time / Late Payments)
  • Current Loan Amount

What Is an Installment Loan?

When you take out a vehicle loan, it’s considered an installment loan. When the loan is on your credit report, it’s reported as an installment account. It signifies to others that the account is a fixed account with a fixed payment over a fixed period of time. There are many different types of installment loans that are reported on credit reports. These include auto loans, mortgage loans, student loans, credit builder loans, and personal loans.

What Contributes to Your Credit Score?

As a consumer, it’s important to realize that each credit bureau manufactures a credit score based on five main factors. By understanding what these five main factors are, you can better work to improve your credit score. The five main factors are your payment history, new credit inquiries, the length of your credit history, your credit mix, and the amount of debt that you owe.

Understanding Your Credit Mix

When it comes to how installment loans affect your credit, you need to first determine your entire credit mix. Your credit mix is what the credit bureaus consider the different types of credit accounts that you have. Your credit mix makes up 10 percent of your overall credit score.

Creditors want to see whether you can handle different types of financing. Your credit mix helps them to determine whether or not you’re financially responsible with multiple different types of credit accounts. When looking at your credit mix, creditors take into account three main types of accounts. These include installment accounts, open accounts, and revolving accounts.

As you learned above, installment accounts are those that have a fixed payment for a fixed term like auto loans. Revolving accounts are usually credit cards and store cards. Accounts have different monthly payments based on the current balance that is on the card or account. Open accounts, also referred to as trade lines, is a general term given to encompass all of the other types of accounts that don’t fit into the installment or revolving account category.

Putting It All Together

Now that you understand what goes on your credit report and what an installment loan is, it’s time to put it all together to see how it can increase your credit score. By getting an installment loan to finance the purchase of a new car, you add to the installment category of your credit mix. The more diversity you have in your credit mix, the higher your credit score is going to be. This is because lenders notice that people who are more reliable in paying multiple different types of accounts are less likely to default on their debts.

When you get an auto loan, you’ve learned that it reports to the credit bureaus. Part of the reporting for that account is the payment history. The payment history is a record of all the payments that you make on a loan. They’re recorded as either on time or late. If a payment is late, it’s recorded as 30, 60, 90, or 120 days late.

Your payment history makes up a very large portion of your credit mix. When you make payments on time, it displays your good payment history, and therefore, your credit score is likely to be impacted positively too. Late payments can report negatively on your credit history. So, they can also decrease your credit score.

What Is a Good Credit Score?

Often, lenders will state that they require a good credit score to qualify for a vehicle loan. It’s important to understand what is considered by the term “good” so that you can ensure that you get the auto loan that you want. In general, credit bureaus refer to anything over 670 as a good credit score.

Your FICO credit score can range anywhere from 300 to 850. Those closer to 300 are considered in the poor range, and those closer to 850 are considered in the excellent range. Those in the excellent range generally will have a wide mix of credit with installment loans, revolving accounts, and tradelines.

Many lenders want to see those closest to the 850 mark, as it signifies to them that they’re reliable borrowers that will repay the loan. These borrowers generally will receive lower interest rates on their auto loans as a reward for being less of a risk for the auto loan lenders. Those in the lower range of 300, 400, or 500 tend to be more unreliable borrowers who may not repay the loan. For this reason, lenders may not approve the installment loan in general. Or, they may charge a higher interest rate on the loan to help mitigate the risk of funding the borrower.

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