Does car finance improve your credit score?

Taking out a car loan can affect your credit score for better or worse – it all hinges on how you manage the money you’ve borrowed.

If you pay the money back on time, it could boost your score. Otherwise, you might dent it and harm your chances of getting credit in the future.

How does car finance affect your credit score in the UK?

On the one hand, you’re demonstrating a commitment to paying back loans and developing a positive repayment history; on the other, your debt load increases and you’re adding a hard search to your record (too many hard searches is sometimes a warning sign to lenders).

But if you do happen to take a hit, it’ll usually be just a small drop – and it’ll be a temporary one, so long as you keep up with your car loan repayments.

Why would a hard search be carried out?

When you apply for a car loan, the lender will perform a credit check (also called a ‘hard search’) to better understand your financial history and behaviour. Ultimately, they want to know how much credit you currently have and how likely you are to make your repayments on time. Each hard check is recorded on your credit report, and companies searching it will be able to see if you’ve applied for credit recently. Having too many hard searches over a short period could impact your chances of being approved for credit in the future.

Can car finance improve your credit score?

Yes, it can – but it’s not a slam-dunk guarantee. Like any credit arrangement, taking out finance to buy a car has the potential to improve your credit score, but if you’re unable to make your payments on time, it could have the opposite effect.

That said, here’s how it could boost your credit score over time:

• You add regular, on-time payments to your credit history: Your payment history is a vital part of your credit score as it demonstrates your ability to pay the money you’ve borrowed back on time. You can avoid late or missed payments and protect your score by setting up an automatic payment, like a Direct Debit or standing order.

• You diversify your credit mix: Your credit score also considers the different types of credit arrangements you have (your credit mix) and how well you manage them. If you take out instalment credit, like a car loan, alongside revolving credit, like a credit or store card, and make the payments on time, you’ll present yourself as a more responsible borrower.

How fast does car finance improve credit score?

Don’t expect a miracle to happen overnight. In fact, you may not see much improvement until a few months later. Your rating should steadily increase over time, so long as you make your repayments each month.

Can taking out car finance harm your credit rating?

It can if you’re not careful. Here’s how:

• You miss car loan payments: If your circumstances change and you’re unable to make your loan payment on time, it could negatively impact your credit score. Many lenders will give you a grace period to make the payment without penalising you – but if you go a full billing cycle without payment, it will be reported to one, two, or all three of the main UK credit reference agencies (Experian, Equifax, and TransUnion) and stay on your report for six years.

• You miss other payments: Likewise, if you take on a large car loan and your income or employment situation changes, or the vehicle requires extensive maintenance or repairs, it could cause you to fall behind on other bills. As above, these missed payments may end up on your credit report.

• You default on the loan and have the vehicle repossessed: A default is when you consistently fail to make your payment on time. Every lender is different, so check the fine print to see how they define it. Once you’ve defaulted on the loan, it could be passed on to a debt collector who’ll pursue you for payment. And if you still don’t pay, the vehicle might be repossessed and sold to recoup the loan. Like a missed payment, a repossession can stay on your credit report for up to six years, making it harder for you to get credit during that time.

Does buying a car with cash help your credit score?

In a word, no. Your credit score shows how well you can manage the money you’ve borrowed. If you don’t borrow anything to pay for your new car and instead pay for it outright with cash, your score won’t be affected by the purchase.

However, depending on the vehicle's cost and your personal circumstances, buying a car with a lump sum of cash could indirectly affect your credit score. If it leaves you short of money, you may be unable to pay other bills, loans, or lines of credit. Those missed payments would subsequently end up on your credit report, lowering your score and harming your chances of getting credit in the future.

While there are some benefits to buying a car in cash (no debt, no interest or other charges), buying on finance can help improve your credit score if you make the payments on time each month. It also allows you to spread the cost of the vehicle and keeps your cash in the bank to be invested elsewhere or used in an emergency.

Does car finance impact a mortgage application?

Yes, as an often expensive monthly outgoing, car finance can significantly impact a mortgage application.

That’s because, when you apply for a mortgage, your lender will carry out an affordability check, which measures whether you can afford to repay the amount you’re hoping to borrow. As part of this check, they’ll look at your employment status, income, expenses, and credit history.

As a rule of thumb, the more debt you already have, the less comfortable a lender will feel adding to it – especially if they’re not sure you can afford to pay it back based on your income. So, a recent large car loan could make a lender think twice and offer you a lower mortgage instead.

Note: If you already have a mortgage, taking out a car loan won’t affect it, so long as you can still cover your mortgage payments alongside your car payments.

To recap:

Car finance can have a positive or negative impact on your credit score. It all depends on how you manage it. As with any credit arrangement, if you make the repayments on time and in full each month, a car loan can improve your score. However, if you miss a payment or default on the loan, it could harm it and make it harder to get credit in the future.

Whatever your number, whatever your goal, the first step towards growing is knowing. With Checkmyfile you get the most detailed credit report on offer. Captured in one convenient spot. Check your file here