David from Marietta asked, “Should I get a car loan to help improve my credit score, especially if I’m looking to buy a house in the near future?”

For relevant background info on this question, please see my articles on Credit Score and Buying a New Car.car loan

The first thing you should consider before answering this question is whether you can actually afford this new/used car. Are your finances in order? Can your budget afford this large purchase and can you confidently tell me that you are going to be able to make these payments every month for the next few years? Would a slightly older model suit your needs just as well and help you save some money on the purchase price?

The next question I’d ask you is about your credit score: Do you know what it is? If you have no idea, then how do you that getting an auto loan will actually improve it? Maybe your credit is so good that you don’t need to improve your score (or, on the flip side, so bad that it won’t help?). Take some time to get familiar with your credit score, learn about where it’s been, and where you’d like it to go (up, up, up!)

Getting an auto loan will cause your credit to take a little hit for a little while, as you’ve suddenly got a lot more money that you owe the bank. With time, as you continue to make the monthly payments, your score will increase (35% of your credit score comes from your payment history). By owing more (in this instance via an auto loan) you’ll improve your score as well (30% of your score comes from your outstanding debt). Finally, 10% of your credit score comes from the different types of credit that you have, and by having an auto loan, that’ll be one more type of credit you have to your name.

So, it is clear that by getting a car loan and paying it off on schedule, your credit score will improve. This leads us to our final question: Will it be worth it? Current mortgage interest rates are right around 4%. Depending on your credit score, your mortgage loan might end up being in the 3.8%-4.2% range. Granted, that’s not a huge difference, but in the long run it would be much better to have the lowest rate possible. People that find themselves in the top third of credit scores (above 700) will typically be offered the best rate. Therefore, taking your score from 720 to 740 might not score you a better rate. You’ll have to weigh the pros and cons and determine whether paying all that interest in your car loan is worth a bump and whether it will really help you.

Getting a car loan is risky. You’re taking on a large sum of debt and promising your future wages to pay it off. You’ll end up paying anywhere from a couple hundred dollars to a couple thousand dollars extra in interest. If your credit score is hurting right now, getting an auto loan will no doubt, with on-time payments, improve your credit score. However, if your credit score is already top-notch, then the incremental benefits of improving your score might not outweigh the incremental costs and risks of getting a car loan.

At the end of the day, take a look at your score and finances and let that help you make an informed decision. Enjoy your new car!

  1. Free Money Minute (@FreeMoneyMinute) says:

    I look at this from a different perspective. Isn’t the point of a credit score to set yourself up to take on more debt? Wouldn’t it be better if you didn’t have debt in the first place? Something to consider if you are taking on debt for the opportunity to take on more debt in the future. To build wealth effectively, I would recommend eliminating debt and make that the rule.

  2. Tsu calls it out says:

    Good day! This post could not be written any better!
    Reading through this post reminds me of my old room mate!

    He always kept chatting about this. I will forward this post to him.
    Pretty sure he will have a good read. Many thanks for sharing!

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