Building Credit: How Financing A Car Can Help

Managing your auto loan responsibly is one key to upping your credit.

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For many car buyers, the handshake to close the sale is just the first part of the purchase; then comes the financing. According to the Federal Reserve Bank of New York, a record 107 million Americans have auto loan debt.

Managing your auto loan responsibly can help you take the wheel of your new car and your credit rating. By making consistent on-time loan payments, you can boost your credit score and increase your eligibility for attractive interest rates down the road. Here’s how building credit with an auto loan works:

Mixing it up

Your credit score is a three-digit number—ranging from 300 to 850 on the widely used FICO scale—that provides a snapshot of your “credit worthiness.” It is used by lenders to decide if, and at what interest rate, they’ll give you a loan. The higher your number, the better.

There are five factors that make up your score.

  • Length of credit (15 percent) looks at how long your accounts have been open. Your auto loan—be it three years, five years or longer—will help build your credit history.
  • The category “mix of credit” and “new credit” each account for 10 percent of your score. Lenders look for both revolving credit lines—such as a credit card—and installment loans, such as an auto loan. Credit mix sometimes receives more consideration if you haven’t used credit for long, so having an auto loan in your mix could potentially be considered a plus.
  • Credit utilization—or the percentage of available credit that has been borrowed—makes up 30 percent of your score.
  • Payment history accounts for the largest portion of your credit score (35 percent). In other words, making on-time payments can improve your credit score more than any other factor.

Putting time(liness) on your side

FICO gives precedence to installment loans over revolving credit, so it’s doubly important to consistently pay your auto loan on time. By doing so, you’ll establish the dependable track record that lenders look for. As your score increases, you’ll be more likely to qualify for better interest rates on not only auto loans but mortgages and personal loans as well.

Creating success

Before you sign on the dotted line, make sure the terms—amount, due date, etc.—are ones you’re comfortable with and can meet throughout the life of the loan. To better manage your loan on your path to building credit, consider setting automatic payments to be deducted from your checking account, or set payment reminders so the due date doesn’t pass you by. Such steps can help you stay on a timely track and keep your credit score on its upward climb.

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