If you just bought a new car with financing, chances are you saw a drop in your credit score. Why is that you may ask?
When you take out an auto loan, 3 of the 5 categories that influence your credit score become affected, which will all be fully discussed below. Thankfully, auto loans are actually one of the most effective methods of raising your credit score in the long run.
If your credit score dropped after buying a car, here are a few reasons why:
You Applied for a New Line of Credit
When you are applying for auto loans, lenders will be checking your credit score to see if you are a “reliable” borrower. Anytime a financial institution lends money, a hard credit check is performed.
Hard credit checks affect the credit category known as “New Credit”.
When you apply for an auto loan and a hard inquiry is performed, you may see a small drop in your credit score.
This usually ranges from 5-15 points per hard credit inquiry.
A hard credit inquiry will be visible on your credit report for two years. However, the effect of the hard credit inquiry will slowly begin to fade as time passes.
This is usually the most common reason why your credit score may drop after getting an auto loan.
You Increased Your Credit Utilization
Credit utilization is how much of your available credit you have utilized. Buying a car takes a significant amount of money, and your credit utilization rate will increase massively.
Experts agree that if you utilize more than 30% of your available credit, your score could be negatively impacted.
Let’s take a look at an example.
Say before you bought a car, you had a credit limit of $1,000 and had roughly a $300 balance on your credit card. To find your credit utilization, divide your credit balance of $300 by your credit limit of $1,000 to get 30%, the ideal credit utilization rate.
If you get a $10,000 car loan, your credit limit reaches $11,000 with a balance of $10,300, including the $300 of credit card debt.
The utilization rate now becomes 93%, much higher than the recommended amount. This can contribute to a large drop since credit utilization accounts for 30% of your total credit score.
You Have a Limited Credit History
Credit history is the last of the 3 factors that can be affected by an auto loan. When you open a new account, the average age of your credit accounts diseases which in turn lowers your score a slight amount.
Consumers who have never used credit before, such as recent college graduates, may experience a larger impact on their credit score since there is no credit history
This factor accounts for 10% of your total credit score. Credit history benefits from having older accounts open.
This is because lenders like to see your credit habits over a period of time.
Although its common for your credit score to drop after buying a car, know that loans are actually a fantastic way to build credit! How much does a credit score drop after buying a car? The answer is, it depends on you and your credit.
It is important to note however that most consumers report an increase in their credit score over time when making payments on an auto loan.
If you are looking to buy a new car but are in need of financing, CrediReady can help.
Our nationwide network of trusted dealers and verified lenders work with buyers in all credit situations. Take a moment to fill out our free no-obligation loan inquiry form and start shopping for your dream car today!