Does Financing a Car Build Credit?
Financing a car can build credit if managed responsibly.
Contributing Writer at Tally
September 17, 2021
If you are looking to buy a car for the first time, you probably have a lot of questions. We’ve touched on topics like whether you should buy new or used and the questions you should be asking during the purchasing process, but you might also be wondering how your purchase will impact your credit score.
In this article, we answer the question, “Does financing a car build credit?” We discuss whether a car purchase is a wise option for building credit, tips to implement and mistakes to avoid.
By the end of this article, you should have a much better understanding of how you can use your car purchase to help boost your credit score.
Does financing a car build credit?
Know that taking out an auto loan could ultimately help build your credit assuming you manage it responsibly. When you take out your new car loan, there will be three main components:
The principal amount borrowed, or the lump sum of the loan
The interest rate, which is what your lender charges you for borrowing money
The loan term, which is how long you have to repay the loan
These three components determine your monthly payment. If you make your minimum monthly car payment on time each month, your credit score will improve.
Although auto financing can improve your credit score, it can also harm it. If you start making late payments, or missing them altogether, you will end up doing damage to your credit score.
It’s important to remember that when you apply for your loan, your lender is going to have to perform a hard inquiry on your credit profile. This will happen whether you secure your lending through a dealership or a third-party lender like a bank or credit union.
A credit inquiry will cause a slight decrease in your credit score. This is not exclusive to auto loans either; it’s something all borrowers deal with whenever they attempt to secure new credit, whether it’s for an auto loan, student loan or credit card.
But if you make timely payments, you’ll quickly begin to rebuild your score. The credit check alone shouldn’t be the sole deterrent to opening a line of credit.
Is a car loan a wise option to help build credit?
A car loan can be a good option for building credit if used correctly. Here are a few reasons why:
Take advantage of a need: A car is likely a necessity if you need it to get to work or school. You might consider taking advantage of a car loan to aid your credit score.
You gain equity: Your car will depreciate in value over time, especially if you buy a brand-new vehicle, however, once you’ve paid off your auto loan, you own the vehicle — you are free to resell it or take advantage of its trade-in value. You don’t have that advantage with other forms of credit, like credit cards.
Fixed loan payments: Building your credit via car payments could be made easier by the fact that you have fixed loan payments each month. This means you know exactly how much you are paying in principal and interest each month. You also know how long you will be making these payments. This can be beneficial when building the payments into your budget. Fixed loan payments are easier to plan for and can potentially hold you more accountable than other lending options.
What are some tips when it comes to financing a car?
If you are looking to finance a car purchase, here are a few tips to consider:
Put money down: Put as much money as you can into a down payment on the car. This reduces the total amount that you need to borrow and could reduce how much you pay in interest.
Shop around: Just because you have nonexistent or poor credit does not mean you should take the first loan offer you come across. Shop around for the best rates — securing a lower interest rate could save you money in the long run.
Consider the total cost of the purchase: Though the sticker price of the car should be a primary concern, it shouldn’t be your only concern. Things like car insurance, warranties and fuel can add up. You can’t finance these costs through your auto loan, so you need to have a plan to cover them before you buy your vehicle.
It’s easy to make an emotional decision when you walk into a car dealership, but being patient during the buying process will benefit you in the long run.
What are some mistakes to avoid when it comes to auto financing?
Because the car-buying process can be so fast-paced, it’s easy to make some mistakes. Below are a few common ones that you want to avoid:
Focusing only on new cars: New cars depreciate by 10% as soon as you drive them off the lot. Used cars that are only a couple of years old are often just as safe and reliable as new cars. You can focus your search on certified pre-owned vehicles to ensure you receive a quality vehicle that’s also affordable.
Not negotiating: Dealers often have wiggle room in their offer. Whether you negotiate loan rates or upgrades, like free service for the first year, you can always look for ways to get a better deal.
Not thinking about financing until you arrive at the dealership: You should do your homework ahead of time and have a good understanding of where you stand financially. Know how much you are willing to borrow and how much you can fit into your monthly budget.
As mentioned, being prepared will go a long way during the car-buying process. The more research you do, the better off you’ll likely be.
What to do if you can’t secure a car loan?
If you can’t secure a car loan, there are still some other ways for you to build credit.
Look into various credit cards designed for those with little to no credit. You may have a higher interest rate than average, but if you pay your balance in full every month, the interest rate should not be a concern. Then, you can upgrade your credit card to something more favorable and secure auto financing. This, in turn, will improve your credit mix and score.
If you don’t have time to build credit this way and need a car immediately, you can consider a cosigner. The cosigner signs onto your auto loan with you and agrees to make payments on your behalf if you do not make your minimum payments on time each month. A cosigner should be someone you trust, like a family member or a close friend.
Build your credit by financing your auto purchase
If you are moving toward financial independence, buying a car for the first time can be daunting. However, it does not have to be — doing your homework ahead of time can help you make an informed decision.
An auto loan can definitely help build your credit score as long as you make your monthly loan installments on time and in full. If you do, you can improve both your VantageScore and your FICO score.
If you have existing credit card debt that is preventing you from financing a car, be sure to look into Tally†. Tally will automatically pay down your balances efficiently, which could potentially put you in a better position to secure future lending.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.