Impact of Credit Score on Car loan

Purchasing a car is an expensive affair for most of us and this is the reason why we finance our car with the help of a car loan. However, before approving your loan application, lenders would like to have a look at several factors that helps them to determine your eligibility and interest rate. One such important factor is your credit score and report. 

Credit scores show your creditworthiness and how responsibly you have managed your finances and credit payments during the past. So, if you are planning to apply for car loans, you need to know that your credit score gets affected when you file your application for car loans. If you remain consistent with payments, your credit score will be improved. On the other hand, if you default or skip your payments, then, in that case, your credit score will get a hit.

What is a good credit score for Car Loans?

There is no universal credit score required for car loans. It largely depends upon the financial institution with whom you have applied. Different banks may look upon different eligibility criteria. However, most of the banks prefer to grant car loans to such individuals who have credit scores of 700 and above. Higher credit ratings make creditors more confident that you will repay your future debts as agreed.

Several factors lenders look for in your Credit Score

By running a check on your credit score, lenders try to understand your ability to repay. They do this by performing a risk assessment based on your financial past and present credit payments. Your credit rating is based on the information mentioned in your credit report. It is comprised of five components, each with a different weight. Let us have a look at all these factors in detail with the level of impact they have on your credit rating.

Payment History- 35%

Payment history is one of the most important factors that affect your credit score. If you have been regularly paying your due bills on time, it will portray to lenders that you have remained a responsible borrower. A responsible credit behavior will also make you eligible for lower rates on loans and credit. Skipping your payments or paying late will lower your score by several points.

Credit Utilization Ratio- 30%

It is the ratio that refers to the total amount of credit you have used in proportion to the cumulative total credit limit available to you. This ratio is calculated by dividing the overall outstanding balance by your total credit limit. Ideally, you should use only 30% of the credit limit to maintain a high score.

Length of Credit History- 15%

The length of your credit history is also considered while computing your credit score. If you have responsibly managed your credit payments during the past and continue to pay your dues on time, it will leave a positive impact on your credit score. A long credit history helps lenders take a sound decision on whether to offer you credit or not and at what terms and conditions. Therefore, it is advised to leave the accounts open that you have had for a long time.

Type of credit accounts- 10% 

It is important to maintain a good balance of secured loans as well as unsecured loans. From the lender’s perspective, having a diversified portfolio of credit accounts seems good. Your credit mix reflects the experience you have with handling both types of credit in reliable ways.

New Credit-10%

Credit score calculations also consider how many new credit accounts you have opened in recent times. Opening too many new accounts may impact the length of your credit history. Too many accounts or inquiries indicates a high amount of risk and it can severely impact your credit rating negatively. So, you should avoid applying for too many credit products at one go to safeguard your credit score from getting hampered.

How can you check your Credit Score?

It is always a wise idea to check your credit score and report before applying for any loan including car loans. You can easily check it online for free at either Fintech portals or by directly visiting the respective credit bureau’s website to instantly know your credit score.

How does my Credit Score affect interest rates on car loans?

Based on your credit score, the lender will decide what interest rate you will be charged. If you have an excellent credit score, the banks will be willing to approve your loan at a low-interest rate. On the other hand, if you have an average score, the chances to secure a low rate on your loan becomes less. 

Different ways a car loan leaves an impact on your credit score

Online Car Loan Application

Whenever you apply for a car loan online, lenders will perform a hard inquiry. A hard inquiry/hard pull is created when the lender requests a credit bureau and asks for the applicant's credit report to evaluate their creditworthiness. Whenever any lender does a hard inquiry, information about the same is also reflected in your credit report. Remember, a single hard inquiry will not affect your credit score much. If you had multiple hard pulls from various car loan lenders in a short duration of time, it indicates the credit hungry behavior of the applicant in the lender’s mind. So, avoid filing multiple loan applications simultaneously.

Be Diligent with Payments

Car loans can help you prove your ability to make consistent payments on a long-term basis. Loan paid on time will portray to your lenders that you can handle a loan efficiently and it will increase your credit score. On the other hand, if you fail to repay your loan EMIs on time, your credit score will get hurt.

Regular Payments

If you are paying your car loan EMIs before or on time, then your credit score will get improved. It shows your responsible credit behavior and the same is also reflected in your credit report. The lenders always prefer to lend loans to such borrowers who make payments on time. Not only this, but borrowers also get some relaxation on the car loan interest rate.

Loan Default

The status of 'loan default' comes when you fail to make your repayments on time. Any delay in paying your loan gets reported to the credit bureaus by the lender which results in reducing your credit score. If car loan EMI payment default continues for consecutive 90 days, you will get NPA (Non-Performing Asset) label on your credit report – a title that bars your chances to get a loan from other lenders.

Conclusion

I hope you understand from the above information that how credit scores work and the impacts that will leave on your credit score while applying for a car loan. Making multiple hard inquiries reduce your credit score and on-time EMI payments will boost it. Therefore, it is always a good idea to check your credit score before applying for car loans.