HOW CAN A CAR LOAN HELP REBUILD MY CREDIT?
Having a decent credit score creates more financial opportunities for you. However, even though everyone knows having good credit is important,less than half of parents are explaining the specifics of managing creditto their kids. It’s also important to know that a low credit score doesn’t mean you can’t improve your financial standing. Financing your next vehicle can be the first step to strengthening your finances in the long run.
Having a low credit score or a challenged credit history no longer limits you from being approved for a car loan. However, you typically have fewer options and sometimes have to take on a loan with a higher interest rate than you may be expecting. But, keep in mind that getting this loan can be your first step to getting your financial independence back. Having an auto loan can improve your status as a borrower and help you regain confidence with your finances, especially following devastating events such as a difficult divorce, declaring bankruptcy, or going through car repossession. Here are four ways a car loan can help you rebuild your credit and develop better debt management habits.
Installment vs. Revolving Credit
The first aspect of auto financing is understanding what type of credit line you are managing with an auto loan. Installment credit is a loan you pay back with monthly payments that stay the same through the duration of the loan. The payment increments and amounts are determined at the beginning of the loan, and do not fluctuate as you’re paying it off. Revolving credit, on the other hand, has a cap on the amount you can borrow, but the borrower can elect to borrow certain amounts of that limit and pay it back at different times. Revolving credit plans, such as what comes with having a credit card, usually have a minimum payment you need to meet each month, and it is best practice to have your debt-to-credit ratiostay below 30 percent. As you can probably guess, an auto loan is an installment debt.
Knowing the difference between these two types is essential to understanding how installment debt affects your credit score differently than revolving credit. Overall, revolving credit, particularly credit cards, significantly affect your credit score, as many consumers fall into the trap of maxing out their credit lines and not paying it back. Since an installment debt has a fixed amount borrowed, the credit bureaus can’t scrutinize your use the way they can with your revolving credit debts.
Timely Payments Show Results
When you are approved for an auto loan, the fastest way to make sure you are in good standing with the lender and see your credit score improve, or at least, not dip lower in the short term, is making timely payments. Instead of making the minimum payment the day it’s due, pay early and add a little extra.
Choose Consistency Over Trying to Pay the Loan Off More Quickly
In 2017, the average American household had more$130k in debtfrom various sources. For auto loans alone, that amount is just under $30k. Looking at these numbers, it can be scary to think that you’re carrying this debt long-term. It may seem like the obvious solution is to just pay the loan off faster, but this can actually have an unexpected negative impact.
If you’re dedicating a lot of your expendable income to paying off your auto loan faster, you may be neglecting other debts or just paying the minimum balance on those. Not giving your other debts the same amount of consideration can land you in hot water in other ways. In addition, putting more towards your auto loan and less in savings means that you are more likely to turn to credit cards in case of an emergency. Lastly, both credit bureaus and lenders like to see an extended history of timely payments. So go ahead and make sure you feel comfortable with the loan term and making your payments on time for the duration, especially if this is your first loan.
Refinance to Qualify for An Even Better Loan
Once you establish yourself as a reliable borrower and have at least a year or two of making timely payments on your auto loan, it’s time to consider refinancing. The process of refinancing or applying for a new loan to cover your old loan while still using the vehicle as collateral, can help you reduce your interest rate, thanks to your increased credit score, and permit you to shorten or extend the loan term.
At the beginning, be prepared to see your credit score dip a few points, as lenders need to make hard inquiries when reviewing your refinancing application. If you submit your applications within the same few weeks, most credit reports will accept that as one hard inquiry, so make sure you rapid-fire your applications once you make the decision to refinance.
Ideally, you want to refinance with two goals: lower your interest rate and shorten the loan term. Reducing the loan term will increase your monthly payments, so make sure you plan for that ahead of time. Your old loan will close, and your new loan will take over. In addition, the new loan will show up as an additional account on your credit report, and that’s a good thing.
Sometimes, it can seem like it’s significantly easier to hurt your credit rather than help it. But over time, your auto loan will help you increase your credit score and improve your personal finances. In addition to getting the car that will take you where you need to go, treat your auto loan as the first step to building a better financial future for yourself. As long as you are responsible with your payments and knowing what else you need to improve on, taking out a responsible auto loan is the perfect way to jumpstart the process of steadily increasing your credit score.
At Fairless Motors, our finance departmenthas over 50 years of combined expertise to help all of our customers get loan approvals for their dream cars, regardless of their credit history. A team member will sit down with you in a relaxed, transparent way and discuss your options in detail. We’ll work out what you can afford, what your needs are, and what vehicle matches those criteria. We’ll help you get the right combination of vehicle from our extensive inventory, and a financing planthat fits your budget.