A car loan can help you financially, and not just because it allows you to buy a car and pay for it over time. Getting a car loan, and making the payments when they’re due will also improve your credit history—and that makes it easier for you to get loans at good rates in the future.
History of Credit
As Consumer.gov explains, your credit history is a record of the money you’ve borrowed and whether you’ve been paying it back. It shows how much you owe, what types of loans you’ve taken out, and if you make payments on time. The information is then summarized in your credit report.
It’s important to establish a good credit history because banks and credit card companies will check your report before offering you a loan or a line of credit, and they’ll base the interest rate they charge you on how favorable your report is. Your credit report will most likely also be checked when you apply to rent an apartment or buy a cell phone on an installment plan.
A car loan improves your credit history in a few different ways. First, if you haven’t borrowed money in the past, your credit report will be blank. Lenders may view that as a red flag because they don’t have any information about how financially responsible you are. In that case, taking out a car loan starts building your credit history from scratch.
Second, even if you’ve borrowed money before, it’s better for your report to show different types of credit rather than just one, as Duke University points out. If you’ve borrowed money with a credit card but haven’t taken out a car loan before, getting the car loan gives you a more diverse mix of credit types and proves that you have experience with different forms of credit.
Finally, making payments on time on your car loan gives you a record of paying responsibly, which looks great on your credit report. This especially matters because failing to make on-time payments will hurt your credit report significantly, as myFICO explains. A history of late or missed payments will make it much harder to get a loan at affordable rates the next time you try to borrow.
If you’re likely to miss payments, it’s better to postpone getting a car loan until your finances are more stable. But if you expect to be able to afford the payments, a car loan can improve your credit history.