Should You Use a Car Loan to Build Credit?

At some point, everyone learns that in order to build good credit, you must take on some debt. Paying the debt back on time ensures your score goes up and usually, credit cards are relied upon for this purpose.

However, when it comes to boosting credit, are there other tools a borrower can use instead, like an auto loan?

The short answer is yes. Car loans can serve as another option for people who have pretty good credit, but want to make it better. The real question is, however, is it a good option? If you want to buy a car and have the cash, would financing instead build better credit than by simply relying on regular credit card use?

Pros of Building Credit with an Auto Loan

Before examining whether an auto loan is a useful credit-building tool, consider the possible advantages of financing instead of paying cash:

• You have to buy a car anyway. If the purchase is going to happen no matter what, why not use it to your advantage? Financing your car purchase could kill two birds with one stone.
• Varied types of credit. Credit ratings improve when you have different types of credit. The more varied your credit, the better. This can include a mortgage, personal loan and yes, a car loan.

Cons of Building Credit with an Auto Loan

It may be true that once your car is paid off (presumably without late or missed payments), your credit score will go up. However, there’s a lot more to consider than this end result.

• Paying late will have the opposite effect. You must be very diligent about making each payment in full and on time, otherwise the plan will backfire. Missing a payment could lower your score.
• You’ll be paying interest. When you charge items to your credit card, you can pay back the balance without ever accumulating interest. Interest is only charged when you carry a balance into the next statement period. You will, however, have to pay interest on your auto loan at some point, no matter what. Plus, the longer the length of your loan, the more you will pay.

Is an Auto Loan a Worthy Credit Building Tool?

Consider this: You’re not going to get a decent rate on your loan unless you already have good credit. Are the extra interest payments really worth the bump up?

Even if you believe so, note that your credit score is determined by a variety of factors, including how much you owe. That loan might actually have a negative effect on your credit until you finish paying it down because it will represent a significant amount of debt for quite a while.

If you’re still relying on a single line of credit to improve your score, it’s not going to make much of a difference who is extending that credit. Credit card or auto loan, the effect on your score will be about the same. Besides, do you really need another bill to keep track of?

If you have to finance your vehicle, that’s one thing. If you have the cash, save yourself the hassle and only borrow when you need to. As long as you’re a responsible borrower, your credit score will reflect it.