Does Financing a Car Build Your Credit?

Financing a car can build credit when you make payments on time, but it can damage your score if you miss payments or take on unaffordable terms.

In our guide, we'll cover how your payment history affects your credit score. We'll also look at the benefits of having a good credit mix and what happens if you pay late. To help you figure out if car finance is a smart move for building credit, or if there’s a cheaper way to do it. 

Ready to see when it's worth considering car finance for building your credit score? Time to hit the road.

This article provides general information and shouldn’t be taken as financial advice. All Carmoola’s finance products are subject to status and terms and conditions.

Key takeaways

• Making car finance payments on time can boost your credit score, as lenders report your payment history each month.
• Missed payments and unaffordable terms can damage your score and limit future borrowing.
• If your primary goal is to improve your credit score, other credit products may be more suitable, such as secured credit cards and credit-builder loans.
• Shop for car finance deals with soft searches and choose terms that you can afford in the long run to keep your credit score safe.

Find out if you qualify for car finance with no impact on your credit score.

How does a car loan improve your credit score?

In most cases, car finance can boost your credit score in two main ways: building payment history and diversifying your credit mix. However, expect a temporary dip from the hard search when you first apply.

Building credit through payment history

Consistent on-time payments drive the strongest credit score improvements from car finance. 

Every month, when you pay your car finance on time, it's like adding a gold star to your credit history. These on-time payments show future lenders you're reliable, gradually boosting your credit score just like with credit cards or any other instalment loan. 

But the magic really happens after 12 months or more. If you've got a thin credit file, steady on-time payments over a few years might boost your credit score, though results vary widely depending on your personal credit profile and lender reporting. 

If you’re rebuilding your credit score after past issues, you might see slower gains, as your starting credit rating for a car loan and payment history with other products matter too.

Late or missed payments? That's when things get messy and fast. Depending on how late your payments are, you'll start to see a negative mark in your credit history. 

Defaults and repossessions are the real villains here, and can cause a serious drop in your credit score. Even agreeing to an "arrangement to pay" leaves a visible marker that future lenders (including mortgage providers) will spot as it can remain on your file for up to 6 years. An arrangement to pay is a formal agreement between you and a lender to repay missed payments in smaller, manageable chunks over time. It’s often used as a short-term fix to help get things back on track without damaging your credit score further.

So, when will you see the results of your score? After several months of perfect payments with car finance products, you'll start noticing improvements. 

Want to protect your payment streak? Link your car payment to payday, keep at least two months' payment tucked away for emergencies. If you sense trouble brewing, contact your lender, who might be able to offer payment support. You can also seek support from Money Advice Trust, StepChange or Citizens Advice, who can provide you with independent debt advice.

Make life easier by setting up a Direct Debit or a Continuous Payment Authority; your payments will be taken automatically when they’re due. That's how financing a car builds your credit successfully over time.

Improving your credit mix

Adding car finance can create a healthy mix of instalment credit (fixed monthly payments) and revolving credit (flexible borrowing like credit cards). PCP finance, HP loan, and personal loans typically show up as instalment loans on UK credit files, telling lenders you've got experience managing credit like a pro.

Leases are the wild card; some report to credit agencies, some don't. Always check your agreement and ask if it impacts your credit score.

One thing to know is that credit utilisation only applies to revolving accounts. Using 90% of your credit card limit hurts your score, but owing 90% of your remaining car finance doesn't affect this ratio.

Adding an instalment loan, like car finance, may improve your credit mix, which makes up a portion of your credit score. However, it’s less powerful than payment history or on-time payments. Think of it as a nice bonus rather than the main event.

The reality is, most UK credit scores are already healthy with just one well-managed instalment account. Opening an extra loan for a credit mix? That's like buying a Ferrari just for the cup holder. It’s unnecessary and risky.

Potential risks of using a car loan to build credit

Taking out car finance will trigger a hard credit check, which may cause a temporary dip in your credit score.

For people with poor credit histories, the costs can be especially high. Some subprime car finance deals have interest rates between 20-50%. Ouch. That's expensive stuff, that massively increases the total cost and makes it harder for car finance to work in your favour. 

Here's another kicker: your car payment could reduce the maximum mortgage available to you. Miss even one payment? And you could undo months of positive history in a flash. A default? That's long-term credit harm that'll haunt you. Lenders see this as a massive red flag. Defaults make it significantly harder to qualify for another car finance and can impact future mortgage applications. 

Negative equity is another headache, especially with PCP deals. Your car's value drops faster than your repayments, meaning you might owe more than it's worth. Early or voluntary termination of these agreements can also damage your credit or lead to surprise bills if not managed carefully. Always check how your lender's policies impact your credit score and final loan outcomes.

Here's our golden rule: budget carefully. Choose a payment under what you think you can afford, then stress-test it. Could you handle a £50 increase or a 10% income drop? Use our car finance calculator to see how this fits into your budget.

Effects of a hard (credit) search

When you apply for car finance, lenders run a hard search on your credit file, which may temporarily lower your credit score. These inquiries are necessary to approve credit and can impact your credit score, but are typically small and fade quickly over time. 

Does financing a car build your credit score if you have lots of hard searches? No, too many hard searches can actually slow your progress. It's like trying to run a marathon after doing 50 burpees.

Soft searches are your best friend here. They let you check eligibility or get pre-approved with absolutely zero impact on your credit file or score. Always use these first to see if you’re eligible for car finance. 

Smart move: limit multiple hard credit searches in a short period to protect your score. Always check whether a lender uses hard or soft searches for your application. Some show up as automotive finance, others as personal loan inquiries on your file. Either way, too many hard searches in a short time period can impact your chances for car finance or mortgage approval down the line.

The Damage from Late or Missed Payments

Late payments or missing them altogether can quickly escalate. A single late payment could leave a negative mark. But repeated missed payments could result in a default, which stays for six years on your record, harming your credit rating.

If you're struggling, here's what to do: contact your lender immediately. Discussing payment arrangements beats defaults every time. Yes, "arrangement to pay" markers are visible to lenders and can limit your car finance and credit score improvement for years, but they're far better than defaults. 

Prevention is key; set up a Direct Debit or Continuous Payment Authority, use reminders, and keep a contingency fund covering at least two payments. UK lenders must treat borrowers fairly, so being open and contacting your lender early often leads to the best outcome, for both your payment history and financial wellbeing.

Is taking a car loan just for credit-building a good idea?

For most, the answer is no. Interest and possible fees almost always outweigh the minor boost to payment history or credit mix for your score.

Let's do the maths: borrowing £10,000 at 10% APR costs over £2,600 in interest across five years. Your reward? Maybe a small boost to your credit rating for a car loan or mortgage application, but actual score improvements vary and aren’t guaranteed. Not exactly a bargain.

Only consider car finance for credit building if you tick all these boxes:

• You genuinely need a car
• You can easily afford the payments without breaking a sweat
• You have a very limited borrowing history (also known as a thin credit file) that needs beefing up

Even then, remember, mortgage lenders love low debts and flawless payment history. 

Always crunch the full numbers: interest, insurance, and any missed investment opportunities for your money. Car finance works best when you actually need wheels, not just credit building.

Alternatives for building credit

If you don’t qualify for car finance or want to build your credit score, these credit-building tools might help. Try secure, lower-cost tools like credit-builder loans, secured credit cards, or rent reporting services. These options can build a credit history without adding debt.

It’s all about steady progress! Start with just one or two tools, and don't rush. Too many applications could hurt your credit. You can expect small improvements in about six months, with bigger gains in a year or two.

For secured credit cards, a small deposit acts as your limit, and with responsible use, you could upgrade in as little as six months. Credit-builder loans are another solid choice, helping you build credit while saving at a low cost.

Conclusion

Car finance can build your credit score through consistent payment history. However, you want to always choose affordable terms, make timely payments, and avoid excessive borrowing that would strain your budget.

Before you apply, it's a good idea to check your credit reports with all three major UK credit agencies and set a realistic new car budget.

If you don't actually need a car right now, you can build credit more cheaply. Secured credit cards or credit-builder loans can be a good option.

You can also check your credit files every few months using a free service. This helps you make sure everything is being reported correctly. Different lenders update at different times. So give it a couple of months after starting a new credit product before you expect to see any changes.

Use our soft-search eligibility checker to see if you qualify for finance without damaging your score.