March 28, 2023

If you live in the United States and your credit score is poor, a car loan might be the perfect way to help improve your credit score.

What Is a Car Loan?

A car loan is typically provided by a bank or financial institution to help someone purchase a car. The bank may then repossess the car if the borrower fails to make the monthly payments they agreed on when taking out the loan. This can decrease any risk of repossession, lowering your debt-to-income ratio and improving your score. For many people with bad credit who want to improve their scores, this can seem like an easy solution to repair their bad credit. 

How Car Loans Work

The first thing to know is how a car loan works. A car loan can take many different forms, but typically, they are secured by your car and usually have a set term of three years or longer. When you start making payments, the bank considers you as making a purchase on your credit card debt instead of using your car as collateral. This works because when you make payments on your credit card debt, they increase your available funds without affecting the value of the vehicle.

When taking out a car loan with bad credit, your credit score can increase over time as long as you make your loan payments on schedule. The primary reason that this works is because it makes you appear to be financially responsible. Even though you aren’t paying off your credit card debt, your payment history looks good on your report. For example, if you owed $5,000 and usually made one payment per month of $1,000 but started making monthly payments of $500 to pay off the car loan, it will look like you are a responsible person who can manage their finances.

Using Informal Personal Loans

Informal personal loans for bad credit are another kind of car loan that allows people with poor credit scores to purchase a vehicle and improve their scores over time. Family members, friends, or even a lending institution can make an informal personal loan. The difference between an informal personal loan and a secured car loan is that in an informal personal loan, you do not need to put up any collateral for the loan to be made. 

Making Payments

In order for your car loan to improve your scores, make sure that you don’t overpay your monthly payments. If you make a payment that you don’t have enough money to cover, the bank will contact you and explain how to improve your payment in order to keep the loan. This could mean anything from making your payments on time, budgeting properly, or consolidating your debt.

Most car loans will have interest rates from 6% to 20%, depending on many factors. If you are looking at higher interest rates for a loan, this isn’t going to help repair bad credit. It’s important to note that even if you pay on time every month and make your payments, your credit scores will not increase in a matter of days. It could take up to two years to see significant improvement in your scores. Because credit scores can be so different from person to person, it’s difficult to know exactly how long it will take for you to see improvement.

So, yes a car loan helps to repair your bad credit, but various factors, including those mentioned above, must be considered.