What Impact Does a Car Loan Have On Your Credit Score?

A car is not just a matter of convenience in our congested cities, but it is also frequently seen as a status symbol. Given the status of public transportation, particularly the challenges with last-mile connectivity, owning a car appears to be a must, even if you despise driving it every day for your ride.

A vehicle, like any other expensive item, is usually purchased with the help of a bank or financial institution. When it comes to getting a loan or credit, your credit score is important. You should be aware that having a credit score (especially a strong one) is a requirement for obtaining loans of any kind.

What is a credit score?

A credit score is a numerical representation of your creditworthiness based on a variety of characteristics related to your financial activity. It goes from 300 to 900, with higher ratings indicating greater creditworthiness.

Factors affecting credit score

  • Regular Repayments on your Credit Accounts
  • Number of Credit Accounts 
  • Credit Utilization Ratio
  • Credit Mix
  • Number of Hard Enquiries on your PAN
  • Credit History

How a car loan affects your credit score?

Now that you know what things can affect your credit score, you should also know how taking out a loan or using a credit card can affect it. Your credit score is affected by every action you take concerning credit. It begins with your credit application and continues until the last EMI is paid and the loan or credit card is promptly closed.

Every credit action, regardless of the type of loan, has the potential to make or break your credit score. Let’s take a look at how your credit actions about a car loan can affect your credit score.

Application for a car loan

Effect on hard inquiries

A vehicle loan is a large-ticket loan that often lasts more than a year. Typically, car loans are for three to seven years. When you apply for a car loan, the lender does a hard inquiry with a credit bureau to determine your creditworthiness. A hard inquiry will be made against your PAN number while the bureau does this. If you plan to apply for other loans and/or credit cards shortly, one more Hard inquiry could hurt your credit score.

Effect on credit mix

The percentage of unsecured and secured loans in an individual’s credit portfolio is known as the credit mix. Lenders and credit bureaus prefer an individual to have a good mix of secured and unsecured loans, indicating that the person is utilizing credit for more than just spending, such as purchasing a home, or vehicle, or obtaining a higher education.

Because a car loan is a secured loan, it may be of assistance to you. If you’ve only used personal loans or unsecured credit like credit cards so far. A secured loan like a car loan can help you balance your credit mix and enhance your credit score. Read the vehicle loan agreement before confirming the loan.

Repayment of EMIs

Effect on repayment history

The repayment of current loans has a significant impact on an individual’s credit score. Repayment history is one of the criteria that determine your credit score, and it has a significant impact. Your credit score will improve if you pay your EMIs on time and successfully. On the other hand, failing to pay your EMIs on time puts your credit score in jeopardy. Furthermore, you may be subjected to additional penalties and late payment fees.

Furthermore, if you are unable to repay the loan and must contact the bank to have it written off or settled. This move may have a significant impact on your credit score, which can take years to repair.

Prepayment of the car loan

You can consider paying off the car loan if you save up or receive a sudden gain in the form of a bonus or from other sources. Prepayment of a loan, like other credit activities, has an impact on your credit score. Prepayment is a good move in the eyes of the credit bureau or lenders because you have saved up and decided to complete the loan by prepaying the principal.

Furthermore, prepaying a car loan frees up the portion of your income that was previously consumed by the auto loan EMI. You can make yourself eligible for any additional loans you choose to take out.

Closure of a car loan

Closing a car loan after it has been paid off on time should not affect your credit score. With a loan taken out of your account, however, you become eligible for additional loans. However, if an account is closed in an unethical manner, such as through a write-off or settlement, the credit score suffers. It’s also a good idea to get a loan closure certificate from your lender once you’ve paid off the loan. This will come in handy if you run across any issues in the future.