Applying for a car loan is a significant financial step for many people. Whether you're buying your first car or upgrading to a newer model, securing finance is often necessary to make the purchase. However, what impact does applying for a car loan have on your credit score? In this blog, we'll explore how car loan applications affect credit scores, what factors lenders consider when evaluating loan applications and how you can minimise any potential negative impact on your credit score.

Understanding credit scores and credit checks

Before looking into how car loan applications can affect your credit score, it's essential to understand what a credit score is and how it's calculated.

Your credit score is a numerical representation of your creditworthiness, calculated based on various factors such as your credit history and borrowing behaviour. Lenders use credit scores to assess your risk as a borrower and determine the interest rates and loan terms you qualify for. Scores typically range from 0 to 1,000 or 1,200, depending on the reporting agency. Higher scores indicate lower credit risk and greater likelihood of loan approval. While there is not set minimum credit score for a car loan in Australia, you will generally have fewer car loan options with a bad credit score and may face higher interest rates. It is also not possible to get a car loan from a reputable lender with no credit check.

Every time you apply for credit, be it a mobile phone plan or car loan, this will be added to your credit history. You can find a detailed record of your credit history on your credit report, which is held by credit reporting agencies.

A lender should only check your credit with your express consent once you have applied for credit and have cleared any pre-screening process that may be in place.

The effect of car loan applications on your credit score

Now, let's address the burning question: does applying for a car loan affect my credit score? The short answer is yes – but there are some important caveats:

• Hard enquiries: when you submit a car loan application, the lender performs a hard enquiry on your credit report. This enquiry can temporarily decrease your score by a few points. However, the impact is temporary and typically disappears from your report within two years.
• Multiple enquiries: while a single enquiry generally has minimal impact, submitting numerous applications within a short period (e.g. within two weeks) can have a more significant impact on your score as it may send a signal to lenders that you're actively seeking credit and could potentially be overextending yourself financially.

Other factors considered by lenders

In addition to credit checks, lenders consider various factors when evaluating car loan applications. These include:

• Income and employment status: lenders assess your income level and stability of employment to determine your ability to repay the loan.
• Debt-to-income (DTI) ratio: this compares your total monthly debt payments to your gross monthly income. Lenders use it to gauge your financial health and ability to manage additional debt.
• Down payment amount: a larger down payment reduces the loan amount and demonstrates your commitment to the purchase, which can improve your loan terms.
• Loan terms: lenders consider various loan terms, including the loan amount, interest rate, and repayment period, to assess the risk associated with the loan.

Minimising the impact of credit applications on your credit score

While applying for a car loan can impact your credit score, there are ways to reduce the impact:

• Do your research: before applying for a car loan, research multiple lenders to compare interest rates, loan terms and eligibility requirements.
• Shop around for pre-approvals: instead of submitting multiple applications, consider getting pre-approval from different lenders. These are ‘soft checks’ that don't trigger hard enquiries and allow you to compare rates and terms without harming your score.
• Space out your applications: if pre-approvals aren't an option, space out your applications over a longer period to minimise the cumulative impact of hard enquiries.
• Consider a finance broker: car finance brokers can help you compare offers from multiple lenders, minimising the impact on your credit score with just one hard enquiry, as well as boost your chances of approval by tailoring your application.
• Maintain good credit habits: timely payments, responsible credit use and keeping your credit utilisation ratio low can help your score recover quickly from any temporary dips.

Understanding the bigger picture of car loan costs

While understanding the impact on your credit score is crucial, there are other financial implications to consider when taking out a car loan:

• Interest rates: higher interest rates can significantly increase the total cost of borrowing. Compare rates from different lenders and negotiate for the best possible deal.
• Loan terms: consider the loan term (length of repayment) carefully. Longer terms may offer lower monthly payments but result in higher overall interest paid.
• Affordability: ensure the monthly payments fit comfortably within your budget without straining your finances.
• Review your credit report regularly: Monitor your credit report for any errors or discrepancies that could negatively impact your score. You can access your free credit report once a year from each of the major credit bureaus.

Special considerations for first-time borrowers

Starting your credit journey with a car loan can be both exciting and daunting. Here are some specific tips before you apply for your first car loan:

• Build credit history early: before applying for a car loan, consider establishing credit with a product such as a credit card to demonstrate your ability to manage credit responsibly.
• Start small: opt for a smaller loan amount with a shorter repayment period to minimise risk and build positive credit history.
• Co-signers: consider having a co-signer or guarantor with good credit history join your application. This can improve your approval chances and loan terms.
• Seek guidance: consult financial advisors or credit counsellors for personalized advice on building credit and navigating car loan options as a first-time borrower.

Understanding the impact of car loan applications on credit scores is essential for borrowers looking to finance a vehicle purchase. While applying for a car loan can temporarily affect your credit score, there are steps you can take to minimise any negative repercussions and secure the best possible deal whether you're a first-time borrower or a seasoned car buyer.