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. Thankfully, auto loans are actually a great way to build up your credit score in the long term.
Here are the 3 categories that a new auto loan will affect.
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. A hard credit inquiry will affect your credit score for roughly 1 year, and an entry will remain on your credit report for 2 years maximum.
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. To find your credit utilization, divide your credit balance of $300 by your credit limit of $1,000 to get 30%, the ideal utilization rate. If you get a $10,000 car loan, your credit limit reaches $11,000 with a balance of $10,300.
The utilization rate now becomes 93%, much higher than most people. This can contribute to a large drop since credit utilization accounts for 30% of your total credit score.
Credit history is the last of the 3 factors that can be affected by an auto loan. 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. When you open a new account, the average age of your credit accounts diseases which in turn lowers your score a slight amount.
Although you may experience a temporary drop in your credit score from an auto loan, know that loans are actually a fantastic way to build credit! 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!