How Do Car Loans Affect Your Credit Score ?

Table of Content

How Are Credit Scores Calculated?
How Do Car Loans Affect Your Credit Score?
How to Maintain Good Credit Score When Taking a Car Loan?
How Can You Offset the Negative Effects of a Car Loan on Your Credit Score?

Car loans are valuable financial tools for anyone who wishes to purchase a vehicle but do not wish to spend a significant amount of their life savings on it. By allowing you to gradually pay the costs in monthly instalments, car loans can help you save thousands of dirhams that are generally spent on upfront purchases.

One of the most important factors considered for offering car loan approvals in the UAE is the credit score of the applicants. However, car loans can also impact credit scores in turn since credit scores are nothing but a representation of how you handle your credit. This is why it is crucial to see how car loans affect credit scores.

Let’s take a look at how car loans affect credit scores, tips to minimise the negative impact of obtaining a car loan on your credit score and more.

How Are Credit Scores Calculated?

Credit scores are three-digit numbers ranging from 300 and 900, indicating the creditworthiness of an individual. If your Credit score is low, you are considered to be a risky borrower, and if it is higher, you are considered a borrower who is less likely to default on debt repayment.

To comprehend the impact of car loans on credit scores, it is crucial to understand the composition of a credit score. When al etihad credit bureau calculates the credit score, the following five factors are taken into consideration:

Repayment History:

It is one of the most significant elements that go into credit score calculation taking up 35% of the total weightage. It assesses your ability and habits of repaying the outstanding money and the interest to the lender.

Amount of Outstanding Debt:

It gets 30% weightage in credit score calculations. It calculates the amount of debt the borrower owes in the form of credit cards, personal loans or other types of credit facilities they have.

Length of Credit History:

Another essential determinant, it contributes up to 15% weightage to the credit score calculations. AECB, the authority in charge of calculating credit scores, examines the total period for which you have been utilising credit facilities in the UAE.

Credit Portfolio Diversity:

It makes takes 10% weightage in credit score calculations. Having various types of credit accounts signifies that the borrower has experience in managing different types of credit.

Credit Enquiries:

Contributing 10% of the total credit score, credit enquiries count the number of both soft and hard credit enquiries made on your credit profile.

Any credit facilities that affect the abovementioned determinants will impact your credit score. Let's assess if car loans impact any of the factors and as a result affect your credit score as well.

How Do Car Loans Affect Your Credit Score?

Obtaining a car loan affects all the five factors mentioned above in numerous ways. Getting a car loan may decrease or increase your credit score depending on the circumstances and sub-factors. The impact begins with your car loan application process and may last till the payment of your last monthly instalment. Let’s take each aspect of credit score calculation mentioned in the above section and examine how car loans can impact them:

Repayment History

Repayment history gets impacted positively each time you make a timely monthly installment on your car loan which ultimately positively impacts your credit score. It depicts your responsible credit behavior and your ability to fulfill long-term commitments.

On the other hand, if you fail to repay your car loan monthly installments on time, your credit report and score will be adversely impacted. Any delay in making a car loan repayment gets reported to Al Etihad Credit Bureau by the lender, which results in lowered credit score.

Amount of Outstanding Debt

Due to the higher weightage given to outstanding debts in credit score calculations, getting a high car loan amount can slightly drop your credit score. However, if you repay the loan instalments on time over the entire tenure of the loan, your credit score will be positively impacted. This also makes up for the few points you lose initially when you get the loan.

Length of Credit History

Availing of a car loan for an extended period and making timely repayments will increase your credit score. A longer repayment duration increases the length of your credit history and builds your experience in using long-term credit tools. A longer credit history increases your chances of achieving an excellent credit score. Moreover, it serves best to keep your car loan open for longer to build up a positive credit score and report. This is why paying off your car loan early may lower your credit score a little since the length of credit is shortened.

Credit Portfolio Diversity

Lenders prefer diverse credit portfolios with a good mix of installment and revolving credit accounts. Your credit cards as considered revolving accounts and car loan installment accounts. Having a good mix of both helps build up your credit report and score. Having both kinds of credit accounts also helps the lender determine how good you are at handling each kind of credit. That’s why obtaining car loans affect your credit score positively.

Credit Enquiries

A car loan is a secured loan that goes on for durations longer than at least one year but shorter than 5 years. When an applicant applies for a car loan, the lending institution makes a hard enquiry at Al Etihad Credit Bureau for credit score and report of the applicant to know about their creditworthiness. Hard inquiries are those that are made after you apply for credit. These may reduce your credit score by up to 5 points. While one hard inquiry will not make much of a difference, multiple ones could have a substantial effect on the score since it indicates a credit-hungry behaviour of the applicant.

How to Maintain Good Credit Score When Taking a Car Loan?

Here are a few tips that can help you to achieve a favorable credit score while obtaining a car loan and while repaying it:

Paying EMIs on Time

Making timely repayments of car loan help offset negative impacts on credit score. If you make regular payments, it helps boost your credit score significantly. However, even a single delayed payment for more than 30 days will certainly dip your credit score since defaulting on payments is recorded in your credit history.

Avoid Loan Foreclosure

Prepayment of a car loan affects your credit score negatively but the impact is not very significant. While prepayment of revolving credit is seen as a good action since it reduces your overall outstanding debt. It may have an adverse impact in the case of instalment credit. AECB considers only the active credit accounts and your behaviour regarding them when calculating credit scores. If you close a loan account like a car loan early, it reduces the initially estimated length of credit and hence lowers the score by at least a few points. Ongoing loan accounts on which regular payments are made are ideal to increase your credit scores instead of accounts that are closed early. Part pre-payment of the loan may not decrease your score as long as you close the loan on the pre-decided time.

Use Car Loan Calculator

Use the car loan calculator available online to find the ideal loan amount and tenure you should get at the available interest rate. This will not only help in reducing your financial burden and effective budget planning but also reduce the chances of loan application rejection. Using a car loan calculator can also help you evade multiple hard credit enquiries on the bank’s part.

Evaluation of Eligibility Criteria

Before availing of a car loan, it is advisable to examine the eligibility criteria available on the lender's official website. Applying for the loan without checking the eligibility requirements may lead to the rejection of your car loan application. In addition to that, submit only one loan application after thorough research. Sending numerous applications will lower the credit score.

How Can You Offset the Negative Effects of a Car Loan on Your Credit Score?

Let’s discuss a few things you can do to minimise the negative impacts of obtaining a car loan on your credit score:

Pay off all other debts before obtaining a car loan to lower your total outstanding balance.
Don't make too many credit inquiries in a short period before taking out a car loan.
Avoid defaulting payments on your car loan. You may get the 'loan default' tag if you fail to repay 3 consecutive or 6 non-consecutive monthly instalments on time. Skipping payments results in high penalty fees and adds higher interest to your loan balance.
Avoid applying for more credit after getting your car loan. Try to settle the existing debts completely before taking on another.

Bottom Line

Credit scores play a vital role in examining the creditworthiness of individuals, measured by considering several determinants. That’s why savvy borrowers pay attention to what impacts their credit score and how before taking out loans or credit cards.

The article has given insights into how car loans affect your credit score both positively and negatively. If your credit score majorly depends on the revolving lines of credit at the moment, i.e. credit cards, a car loan will help you in the long run. Make it a rule to never default on EMIs and apply for the loan only when you for sure clear the eligibility criteria the lender has set.

You can also connect with the in-house team of insurance experts at Policybazaar UAE for assistance. We will help you choose the appropriate car loan products aligning with your unique requirements. You can easily compare the top car loan products and pick the perfect plan on Policybazaar.ae and get your car financed in no time!