There’s no way around it – most people in a modern economy must borrow money to purchase large assets such as cars. Unless you can raise money fast, your savings will buy less as time goes on as prices rise due to inflation. The new car you want now will not cost the same as a new car one, two, three years from now. Many people ask when taking out finance, will applying for a car loan affect my credit score? Please read on to find out more.
One way of raising that money is through loans – in exchange for giving you money now, a bank or lender will recoup their costs and make a profit through interest. This is a risk the lender must take as some people may not pay the loan back.
How does a lender determine who is riskier to lend to than others? In the digital age, it’s common for lenders to check a customer’s credit score.
Credit scores and credit applications
Whenever you apply for credit, be it a mobile phone plan or car loan, a lender will check your credit history. Any credit checks a lender makes is recorded on your credit history. A lender only checks your credit with your express consent once you have applied for credit and have cleared any pre-screening process lenders may or may not have.
This affects your overall “creditworthiness” or ability to pay back a loan without running into financial hardship. High creditworthiness means lower risk for lenders, and vice versa. Creditworthiness can affect things such as your application being approved or not, and even what interest rate you get.
Here's the short answer – but the real answer is more complex
The short answer to “does applying for a car loan affect my credit score?” is yes – it does. There really isn’t any way around it.
This isn’t good or bad in and of itself. As we mentioned earlier, any credit check will move the needle on your credit score. Paying off your loans and credit cards on time and in full will keep your credit score can increase your credit score over time. Problems occur with your credit score if you miss repayments, default, or apply for multiple credit products in a short span of time.
More credit checks, lower creditworthiness
If you consent to many credit checks more often, this will negatively affect your credit score. If many lenders reject your applications for car loans, it may mean you are trying to overextend yourself financially, and/or they believe you do not have the capacity to service (pay back) a car loan.
How to minimise the impact on your credit score
You can check your credit score for free each year using one of Australia’s credit reporting agencies. This can reveal if there are mistakes on your report, which you must correct yourself.
If your credit score is lower than average, you should be prepared for higher than normal interest rates. You might be able to offset this by having a deposit or trade-in for the car you want to buy. Or, wait a few months and pay off debts to see if your score rises.
Remember to consult a financial professional before making any major financial decisions.