A car is not only a matter of convenience in our jam-packed towns or cities, it is quite often considered a status symbol too. Also given the state of public transport especially the last mile connectivity issues, owning a car seems much like a necessity even though you may detest using it every day for your commute.
Like any other asset that costs a lot, a car is also generally bought on a loan from a bank /financial institution. And when the question of a loan or credit arises, your credit score comes into play. You must be aware that your credit score (that too, a good one) is absolutely necessary for you to get credit of any sort approved.
For those who are wondering about what is a credit score?
Credit Score is a numerical representation of your creditworthiness as measured by various factors of your credit behavior. It ranges between 300-900 with higher scores representing higher levels of creditworthiness.
What are Various Factors That Can Affect Your Credit Score?
Different factors of your credit behavior contribute to the calculation of your credit score. The main factors that affect your credit score are:
Regular Repayments on your Credit Accounts
Number of Credit Accounts (If they are negative or positive)
Credit Utilization Ratio
Number of Hard Enquiries on your PAN
How Can A Car Loan Affect Your Credit Score?
Now that you know what factors can affect your credit score, it is also important to know how availing a loan or a credit card can affect your credit score. All actions that you take in relation to a credit can affect your credit score. It starts right from your application to credit till the payment of last EMI and the prompt closure of the loan or the credit card.
CreditMantri, as your credit coach always likes to see you take right decisions in regard to credit and hence, would like to help you analyze how each aspect of your credit action could affect your credit score.
No matter what the kind of loan, it has the possibility to either make or break your credit score with each credit action. Let us see how different credit actions of yours with regard to a car loan can end up affecting your credit score.
Additional Reading: Learn more about used car loans
Application for a Car Loan
Effect on Hard Enquiries
A car loan is a big-ticket loan that could go on for a duration longer than a year. Often the car loan tenures range between 3-7 years. When you apply for a car loan, the lender makes a hard inquiry with credit bureau to know about your creditworthiness. While the bureau does that, a hard inquiry will be counted against your PAN number. If you are planning to apply for other loans and/ or credit cards in the near future, then one more Hard inquiry may not bode well for your credit score.
Effect on the Credit Mix
Credit Mix is the proportion of Unsecured and Secured Loans in the Credit portfolio of an individual. Lenders and Credit Bureaus expect an individual to have a healthy mix of secured and unsecured loans which portray that an individual is using credit not only for spending but for investing in assets like a home, car or an higher qualification.
An application to a car loan may help you in this regard as it is a secured loan. If you have just availed personal loans or unsecured credit like credit cards till now, a car loan which is a secured borrowing may help you set your balance of credit mix right and improve your credit score.
Repayment of EMIs
Effect on Repayment History
Repayment of current loans plays a big role in deciding the credit score of an individual. Repayment history is one of the factors determining the credit score and it has a high impact on your credit score. Prompt and successful repayment of EMIs on Car Loan will add to your credit score. And on the other hand, by not repaying the EMIs on time, you are risking your credit score. In addition, you may also end up incurring additional charges on penalty and late payment fee.
Further, if you are unable to pay off the loan and have to approach the bank to write-off or settle the loan, this action may see a big impact on your credit score which can take years together to set right.
Prepayment of the Car Loan
If you save up or have a windfall gain in the form of bonus or from some other areas, then you might consider to pay off the car loan. As with other actions to credit, prepayment of a loan also has a bearing on your credit score. In the eyes of the credit bureau or lenders, prepayment is a good action as you have saved up and decided to close the loan by prepaying the principal.
In addition, when you prepay a car loan, you would be freeing up that part of the income which was being used up by the car loan EMI. You may make yourself eligible for any further loans that you may be planning to avail.
Closure of a Car Loan
A closure of a car loan after the loan has been paid off promptly should not affect your credit score in any way. However, with a loan off of your account, you make yourself eligible for other loans. However, if an account is closed in unsavory methods like a write-off or settlement as we discussed earlier, the credit score takes a hit.
Also when you pay off the loan, it may be good for you to obtain a loan closure certificate from your lender. This will be of good use if you land up in any problems at a later date.