Did you know that financing a car can be a powerful way to build your credit? Regular, on-time payments demonstrate to lenders that you are a reliable borrower, which is crucial since your payment history makes up 35% of your overall credit score.
Can a Car Loan Improve Your Credit?
Yes, securing a car loan can be an effective way to boost your credit score, particularly if you have a lower credit rating. By consistently making payments on your car loan, you can enhance your payment history, which is a key factor in improving your credit score.
Your credit score is influenced by several factors, including your payment history, the amount of debt you owe, the length of your credit history, the types of credit you have (revolving or installment), any new credit, and your overall payment behavior. This score, which ranges from 300 to 900, reflects your creditworthiness as a borrower.
While all these factors contribute to your credit score, each one is weighted differently.
How Do Car Loans Build Credit?
Your payment history is the most significant factor, accounting for 35% of your credit score, while 30% is based on how much of your revolving credit you’re using. Successfully repaying loans and maintaining a low credit card balance can positively influence these major components of your credit score. Conversely, struggling to manage debt and missing payments can negatively impact your score, reducing your chances of being approved for future loans.
If your car loan includes cashback, you can further improve your credit score by using the cashback to pay down your credit card balance.
Advantages of Using a Car Loan to Build Credit
Here are three key reasons why an auto loan might be an excellent choice for rebuilding credit:
- Auto Loans Are Secured
Auto loans are secured loans, meaning they are backed by collateral—in this case, the vehicle itself. If you fail to make full monthly payments, the lender can repossess the vehicle. This security often results in lower interest rates compared to unsecured loans, where approval is based solely on your creditworthiness. For borrowers with less-than-perfect credit, secured loans like auto loans can offer lower interest rates and more manageable payments.
- You Need Credit to Build Credit
To improve your credit rating, it’s essential to show lenders that you can manage a diverse mix of credit responsibly. Making on-time payments on existing credit accounts will improve your score, and adding a new type of credit, like an auto loan, can further enhance your credit mix. However, it’s important to avoid missing or making late payments. Keeping the auto loan open for at least a year, even if you can pay it off sooner, demonstrates consistent, responsible payment behavior, which is crucial for building credit.
- Car Loans Are Easier to Get Approved For
Subprime loans are available for borrowers with below-average credit scores—typically under 670 in Canada. While many dealerships may not cater to subprime buyers, a growing number of dealerships and services like Canada Drives specialize in these loans. Canada Drives, for instance, can get you pre-approved for a car loan online in minutes, making it easier to find financing that fits your situation.
How to Rebuild Credit with an Auto Loan
If you’re ready to improve your credit with an auto loan, follow these steps to prepare, apply, and get approved:
- Bring Current Commitments Up to Date
If your existing credit accounts are past due, maxed out, or in collections, you should catch up on the minimum payments before applying for a new car loan. While you don’t have to pay everything off, being current on your payments is crucial.
- Save for a Down Payment
Offering a down payment of at least 10% of the vehicle’s purchase price can increase your chances of loan approval. A lower initial loan amount reduces the lender’s risk, making it easier for you to secure financing.
- Spend Within Your Means
Consider purchasing a more affordable vehicle if your debt-to-income ratio is high or your income is modest. Keeping your payments low ensures that you can manage them without overextending yourself.
- Avoid Multiple Applications
Submitting credit applications to several lenders or dealers at once can harm your chances of approval. Instead, use a service like Canada Drives to match your application with the right lender, helping you secure the best possible rate.
- Pay on Time, Every Time
Late or missed payments can stay on your credit report for up to seven years, signaling to lenders that you may not be reliable. Ensure that you make your car loan payments on time and in full every month. Avoid relying on grace periods as well.
Get Approved with Auto Lend Experts
The right car loan can be a stepping stone to better credit and financial stability. Autolend Experts can help you find a vehicle and financing plan that fits your budget. Get pre-approved today, free of charge, to see what options are available to you.