Before taking out a car loan, you need to shop around. That is, understanding from each lender how much they’d be willing to finance and at what interest rate. You will have a hard pull or hard inquiry into your credit files by each lender you contact, which will knock off a few points from your credit score. But, with installment loans (a lump sum of money you have to repay in installments up to a specific date), multiple hard pulls done within a specific time frame are all counted as one. The time frame depends on the credit bureau and can go up to 45 days.
Once you’ve zeroed in on the lender and the loan and taken out a new line of credit, your credit history will go through two changes. One, the average age of your active credit accounts will decrease, lowering your score by a few points. Two, because it is a different type of credit – an installment loan – it adds to your credit mix. This could add a few points to your credit score.
Typically car loans are fairly long-term (more or less five years). And, since these are installment loans, you pay a fixed amount each month at a specific time, consistently reducing your balance. These monthly car loan payments can add significantly to your payment history, which accounts for 35% of your FICO® score. Your credit mix contributes 10% while the length of the credit history and new credit are 15% and 10% of your credit score.
In short, your credit score initially drops by a few points when you first take out the car loan. But later on, with timely payments, the car loan should help you improve your credit score immensely by adding to your payment history, increasing your credit mix, and reducing your credit utilization.
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