It’s difficult not to be concerned about your credit rating, as it can have a huge impact on your future chances of borrowing money. Better mortgage deals, loans and car finance packages are offered to those with a higher credit rating, so you may be wondering about the effect of car finance on this. So, does a car loan build credit or have a negative impact?
In the short term, applying for any credit agreement (including a car loan) can have a negative impact on your credit rating. However, if you make your payments on time, having a vehicle loan can help you to build your credit score over the long term.
Applying for a car loan
The first stage of the process is selecting appropriate finance. Once you have found a finance package that will suit you, then next step is to apply.
The very process of applying for car credit may have an impact on your credit score - even before you sign up to any kind of deal. This is because multiple applications for finance can have a negative impact on your credit rating.
This can be avoided by minimising the number of applications you make. Apply for your preferred deal first, and only make your way down the shortlist if this is not successful.
The other thing you can do is check before you apply whether a ‘soft’ or ‘hard’ credit check applies, as each affects your credit score differently.
Hard vs soft checks
Soft credit check
Companies can take a look at just some of the information on your credit report. They do this to see how likely a successful application would be, without checking your entire credit history.
Hard credit check
If the company searches your entire credit report, this is known as a hard credit check. These are noted on your file, and too many in a short time frame can lower your credit score. This can reduce your chances of obtaining credit for around six months.
The effect of hard credit checks
Hard credit checks are therefore best avoided. If your report shows a lot of these checks over a short time period, lenders might assume you are in financial trouble and will thus see you as high risk. This means they might refuse your application, or only offer you packages with higher interest rates.
Repaying the car finance
Assume you’ve secured your car finance. Next, you need to make the repayments. How things go from this point can determine whether you build up a good credit rating - or reduce your credit score and therefore your chances of getting good deals on borrowing in the future.
The best way to ensure you help, rather than harm, your credit score is to make your payments every month on time and in full. If you do this, then borrowing money to buy a car can help to improve your chances of borrowing more money at good interest rates in the future. This is why taking out a car loan or other types of finance can actually help you secure mortgages and other loans later on.
If you default
If you do not make the repayments, then you are breaking the terms of the agreement. This applies whether you take out a secured or unsecured loan, personal contract plan, hire purchase or conditional sale agreement. Unless you have an unsecured loan, your car is at risk of being repossessed if you do not pay the agreed monthly amounts. If you have an unsecured loan, the lender can take you to court in an attempt to get their money.
No matter what kind of car finance or loan you have, failure to make payments will have a negative impact on your credit score - and seriously hamper your chances of future borrowing.
The bottom line
If you pay on time and in full every month, taking out a car loan will build your credit score. If you fail to pay, then this will have the opposite effect and may harm your chances of obtaining credit from then on.