How Auto Financing Can Impact Your Credit

5 Ways Auto Financing Can Impact Your Credit Score

Your credit score plays a big role in your financial life, and when it comes to auto financing, it can influence your ability to secure lower interest rates. But it also works the other way: Auto financing may have a considerable influence on your credit score. That influence can be positive or negative, depending on how you handle your financing commitment. If done responsibly, auto financing can be a means to building a strong credit profile. Here are five different ways auto financing can impact your credit score.

1. Credit inquiries

   The impact of auto financing on your credit score starts early in the process. Note that when you apply to prequalify for auto financing, your credit score won’t be affected. It’s when the dealer submits your application that a finance company will make a hard inquiry or hard pull of your credit report, which may temporarily lower your credit score. And multiple hard inquiries within a short period, such as when you're shopping for the best auto financing rates, can lower it further.
   
   The good news is that most credit scoring models typically treat scenarios like this as a single inquiry to minimize the impact to your credit score. Even so, it’s a good idea to limit those hard pulls to your credit report when you’re applying for auto financing.

2. Payment history

   Your payment history is one of the biggest factors in credit scoring, so a key to establishing and maintaining a high credit score is to consistently make your payments on time. Think of payment history as the experience portion of your financing resume. Timely payments show lenders that you’re a reliable borrower they can trust with better financing terms.
   
   On the other hand, late or missed payments can hurt your credit score, leading to late fees, higher interest rates and damage to your credit history. If you have a lower credit score due to late or missed payments, remember it’s never too late to start building a positive payment history.

3. Credit mix

   Another way auto financing may positively impact your credit score is related to the diversity of your credit. Not all credit is the same. Auto financing contracts are different from revolving credit accounts like credit cards. Financing involves a fixed amount borrowed and repaid with fixed monthly payments, while a credit card allows borrowing up to a credit limit with flexible monthly payments.
   
   Having a diverse credit mix may result in a higher credit score because it shows you can handle different types of credit responsibly.

4. Contract length

   The length of your financing contract may also impact your credit score. Longer contracts such as 60 or 72 months can have a positive impact on your credit score because they show you can manage long-term financial commitments.
   
   When considering the length of your financing contract, keep in mind the overall cost and your financial goals. While longer terms may improve your credit score, they can also result in paying more in interest over time.

5. Credit utilization ratio

   Another big factor in your credit score is your credit utilization ratio. This is how much of your available credit you’re using at a given time. It’s generally recommended to use below 30% of your available credit to maintain a good credit score. So when financing a vehicle, you’ll want to remain below that 30% mark to maintain your credit score.
   
   Understanding how auto financing impacts your credit score is crucial for maintaining a healthy credit profile. Factors such as credit inquiries, payment history, credit mix, loan term and credit utilization ratio all play a role in determining your credit score. Making timely payments, managing different types of credit responsibly and using less than 30% of your credit may help you build and maintain a strong credit profile.

By Ross Appleton, GM Financial

Ross Appleton loves to help people navigate their toughest challenges. He believes that clarity is the key to flourishing in a complex world, and that a timely dad joke is good for the soul. When he isn’t talking or writing about big ideas, you’ll likely find him reading about them in old books. He is married, and two of his four children currently serve in the U.S. Army.