Buying a new car is an exciting experience, but the new car smell doesn't always make up for the money you're shelling out. Plus, if you're considering for applying for another loan, such as a mortgage, in the near future, the impact on your credit score could be costly. How you pay for your new vehicle determines whether it will drop your credit score or not.
If you're paying cash, buying a new car won't have any impact on your credit report. Your credit score only includes information about your debts, such as car loans, but doesn't include any information about your assets, such as the money you have in your checking account or the value of your vehicle. So, since there's nothing to report, your purchase won't affect your credit score more than buying groceries.
If, on the other hand, you do take out an auto loan, your credit score could drop immediately following the purchase because you're increasing the amount of debt you owe. Just under one-third -- 30 percent -- of your credit score comes from how much debt you carry relative to your borrowing capacity. While a car loan isn't nearly as bad as having a credit card debt of the same size, it's still additional debt that you're taking on. Since that increases the risk that you could have trouble paying your bills, your credit score drops a bit.
Your credit score also might get a slight ding -- typically less than five points -- for inquiries related to the car loan. Generally, lenders pull your credit score when you apply for credit, which results in an inquiry on your credit score. At long as you do all of your rate shopping within in a short period of time, generally two weeks or less, all the car loan inquiries are only counted as one for credit scoring purposes, so it will have a minimal effect on your credit score.
Eventual Score Improvement
The long-term effect of a car loan on your credit score isn't all bad, however, First, your payment history counts for 35 percent of your credit score, so making your monthly payments on time every month gives your score a boost. Second, using a car loan gives you a wider range of types of credit used, which improves your score. Third, the inquiries remain on your credit report for up to two years, but only effect your credit score for one year.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."