Car loans can help -- and hurt -- credit
You slide behind the steering wheel of the latest model at the dealership and the moment you put it in drive, you're in love -- forgetting about the price tag. After all, people finance vehicles all the time, why should you worry?
"It's important to recognize that just by having a car loan, you aren't going to ruin your credit," says Gary Tymoschuk, vice president of operations at the Credit Counselling Society. And, in fact, while you have the loan, if you pay on time every month, you can boost your credit score.
"But there are some factors that can negatively affect a person's credit rating," Tymoschuk says.
Shop around, but don't drag it out
In the credit rating world, every time you apply for a new loan, there is
a "hard pull" - an inquiry -- on your credit record, which slightly lowers your credit score. Too many hard pulls can make you look desperate
Simply test driving cars can create hard pulls on your credit record. A single dealership could check interest rates for you from a handful of lenders, leaving you with up to five inquiries from one test drive.
But it's not as bad as it sounds. Car loan inquiries are posted individually, but multiple inquiries from one dealer should only count as one hard pull on your credit report. Therefore, if you go to five dealerships, you might have 25 individual inquiries listed, but they should only count as five on your score.
Credit rating agencies also understand that if you're car shopping you'll likely rack up a lot of inquiries in a short time, and they make adjustments for that. Equifax Canada, for instance, counts multiple hits within 45 days as one hard pull, according to the Equifax website, allowing you to take a realistic amount of time to shop for big ticket items.
So don't be afraid to shop around. Buying a car is a serious commitment, and you don't want to accept the first deal you're offered. But it's in the best interest of your credit score to keep your car shopping within about six weeks.
Timely repayments help your score - until you
pay the loan off
Good behaviour with your car loan can help your credit record by showing you can handle an instalment loan in addition to the unsecured debt (credit cards) you may already carry. But it only helps as long as you're making car payments.
"My biggest problem with car loans that people don't understand or realize is that they're constantly being told that if they want to rebuild credit, a car loan will help," says Richard Moxley, author of The Nine Rules of Credit and spokesman for eCredit Fix, which helps consumers learn about improving their credit score. "But the moment you pay off your car loan, it's no longer helping your credit because it's not current information anymore." That also applies when you refinance your car or take on a new lease, he says.
"When you refinance your car, it stops that account and you're starting all over again," he says. "You don't realize all your hard work for the past 12 months starts all over again."
That doesn't mean you should delay paying off the loan, of course. Just be aware that when you do, it will affect your credit score.
It could affect your other credit needs
If you're car shopping and house shopping at the same time, try to secure your mortgage first, says Moxley. There are a couple of reasons your car should take a backseat -- pun intended -- to other large borrowing needs.
Car shopping can drop your credit score enough so that you are charged a higher interest rate on your mortgage, Moxley says. Additionally, you'll look like you're servicing too much debt to be able to shoulder a mortgage.
However, if you already have a car and you're house hunting, don't pay off your car too soon either, because you don't want to lose the credit history propping up your score.
Moxley says the benefits from a longstanding car loan are "almost lost immediately" after the loan is paid off, and decrease even more as the months pass. The account stays on your Equifax report for up to seven years, but it's updated as "closed" and becomes an old account. Good, current accounts are what keep your score up.
With TransUnion, he says, the drop in score for a paid out car isn't as dramatic as it is with Equifax, but it does take a toll as soon as the account is registered as paid.
Moxley has seen this happen firsthand: clients will pay off a car loan to prepare for a mortgage, only to find they're declined or charged higher rates. "I always tell people to make sure they have other established credit tools, like cards and lines of credit," he says. "Don't just use cars to build your credit."See related: Beware high-interest instalment loans, 4 ways to build credit without a credit card
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