How car finance can improve your credit score

When it comes to building a solid credit score, many people believe that they must make drastic changes in their financial habits. However, using finance in the right way can actually play a significant role in boosting your score. 

If you've been struggling with your credit history or have a low score, you might feel like getting a loan for a car is out of reach. The truth is, when you handle car finance responsibly, you can improve your credit rating over time. With the right approach, car finance can be a tool to enhance your financial standing. Here's how to do it properly.

Understand the impact of car finance on your credit score 📊

The first step when trying to improve your credit score is to understand how it works. In short, your credit score reflects how well you manage your debt, and it plays a key role in many financial decisions, from applying for mortgages to securing loans. 

When you take out car finance, you essentially take on a new form of credit. How you manage that credit will influence your score. If you're approved for car finance, you're committing to make regular payments over a set period. These payments will be reported to the credit reference agencies, so lenders will be able to see your repayment habits. It demonstrates to credit agencies that you can handle credit responsibly, which can gradually improve your score.

Make payments on time and in full

One of the most effective ways to improve your credit score using car finance, is by making payments on time. Missed or late payments can have a negative impact, causing your score to drop significantly. On the other hand, consistently meeting your payment deadlines shows that you are a reliable borrower.

If you find it difficult to remember payment dates, setting up automatic payments or reminders can help. Paying more than the minimum due each month can also be advantageous, as it shows your commitment to paying off your debt faster and reduces your overall balance quicker. Lowering your outstanding debt can have a positive effect on your credit score, as it demonstrates that you’re managing your finances with care.

Understand your affordability 💰

Even if your credit score is good, lenders will look at how much of your income is already committed to other debts, known as your total debt-to-income ratio. This includes car finance, personal loans and credit cards. 

As a general rule of thumb, you should aim to keep your total monthly debt repayments below 30-35% of your gross monthly income. When taking out any form of credit, you should consider what your financial situation may be during the entire loan period. For example, if you're planning on applying for a mortgage during the repayment period, this should be accounted for as any form of existing credit will be evaluated by future lenders.

New research shows that just 13% of car finance customers are already homeowners, meaning up to 87% could be looking to apply for a mortgage in the near future.

Keep your balance low

As you make payments, you're reducing the total amount you owe, which can lower your overall credit utilisation rate. A high balance relative to your credit limit can hurt your score, but as you pay down your loan, your credit score should gradually rise.

This is particularly important if you're financing a car through a hire purchase or personal contract purchase plan, where the total loan balance reduces over time.

Avoid new credit applications ❌

While taking out car finance might feel like a big commitment, it's a good idea to resist the temptation to apply for additional credit while you're paying off your loan. Every time you apply for credit, it creates a 'hard inquiry' on your report, which can temporarily lower your score. Multiple inquiries within a short period can signal financial instability to potential lenders.

Instead of applying for other credit cards or loans, focus on managing the car finance you already have. Once your current loan is paid off or nearly finished, you'll be in a stronger position to apply for additional credit if needed, without damaging your score in the process.

While we advise this is best practice, everyone's personal circumstances will differ meaning it won't always be possible to adhere to advice. Making the minimum payment on your car finance should always be a priority and anything more than this is a bonus.