As a millennial just starting out, you likely want to establish good credit as quickly as possible. Few people today can live on a cash basis only, and having good credit – and using it wisely – makes your life much easier. Naturally, you want and probably need a credit card, but did you know that buying a new car could be one of the best decisions you make when it comes to establishing good credit?
It’s true. Not only does obtaining a car loan add to your credit mix, but it also provides you with new credit. Together, these two factors account for 20 percent of your FICO credit score. In addition, your payment history accounts for another 35 percent. So if you make all your car payments on time, you now have 55 percent of your overall score in the “positive” column. You have now established good credit while enjoying the fun of driving a new car.
How a Car Loan Initially Affects Your Credit
When you go shopping for a new car loan, keep in mind that the dealer likely will send your application to multiple lenders. This is one of those good thing/bad thing situations. Whenever a lender looks at your credit report prior to giving you a loan, this is called an inquiry, and a few points drop off your credit score. Too many inquiries not only has a cumulative negative effect on your score but also can look suspicious with regard to why you are applying for so much credit all at once.
On the other hand, when you apply to multiple lenders for a car loan, all of their inquiries generally count as only one if all of them are within a 30-day period. So don’t drag out your car shopping unnecessarily. Make your decision as quickly as possible.
How a Car Loan Affects Your Credit Long-Term
You make up and overcome that initial small drop in your credit score caused by lender inquiries when you make all your car payments on time. Since most car loans nowadays are for 60 months or more, the longer you make your payments on time, the better your credit score becomes. Even six months’ worth of on-time payments can significantly boost your score.
Another good point to consider is that if your car loan carries a high interest rate due to the fact that it represents your first installment loan, you can refinance it with a different lender at a lower rate once you establish a good payment history. Not only will refinancing reduce your monthly car payments, but it also will save you a considerable amount of interest over the life of the loan.
How a Car Loan Affects Your Mortgage Eligibility
Sooner or later, you probably will want to buy a home. This is another way in which establishing credit with a car loan can help you out. A mortgage is another form of installment loan, but a considerably bigger one than your car loan.
When mortgage lenders check your credit score to see if you are a responsible money manager who always pays your bills on time, all your on-time car loan payments will prove to them that you are a good risk for a home loan. In addition, while your on-time credit card payments also help your credit score, they have considerably less effect when it comes to getting a mortgage loan for your home purchase.
All in all, obtaining a car loan and paying it off responsibly and on time is a great way to establish your credit. It goes without saying that the better your credit, the better the life you can expect to live. And if you can have the pleasure of driving a new car at the same time, that’s a real bonus!