Does Applying For a Car Loan Hurt Your Credit Score in Canada?

When you're thinking about buying a car, one of the main concerns might be how applying for a car loan will affect your credit score.

 

Understanding this can help you make better financial decisions and feel more confident about the car-buying process.

Understanding Credit Scores

Before diving into how a car loan application impacts your credit, it's important to understand what a credit score is. A credit score is a numerical representation of your creditworthiness.

 

It helps lenders decide how risky it is to lend you money. Credit scores range from 300 to 850, with higher scores indicating better creditworthiness. They are calculated based on several factors:

 

• Payment History: Whether you pay your bills on time.

 

• Amounts Owed: How much debt you have compared to your available credit.

 

• Length of Credit History: How long you've had credit accounts.

 

• New Credit: How many new credit accounts you've opened recently.

 

• Types of Credit: The variety of credit accounts you have, such as credit cards, mortgages, and loans.

 

Hard Inquiries vs. Soft Inquiries

When you apply for a car loan, lenders check your credit report to assess your creditworthiness. This check is known as a "hard inquiry" or "hard pull." It's different from a "soft inquiry," which occurs when you check your own credit or when a lender checks your credit for pre-approval offers.

 

• Hard Inquiry: This happens when you apply for credit, like a car loan. It can affect your credit score.

 

• Soft Inquiry: This occurs when you check your own credit or when a lender pre-approves you for an offer. It does not affect your credit score.

 

How Hard Inquiries Affect Your Credit Score

A hard inquiry can slightly lower your credit score, usually by a few points. This impact is generally minimal and temporary. Here’s what you need to know:

 

• Minor Impact: Each hard inquiry typically reduces your credit score by less than five points. This is a small change and usually not enough to significantly affect your ability to get credit.

 

• Short Duration: The effect of a hard inquiry on your credit score is temporary. It usually lasts for about 12 months, but the inquiry itself remains on your credit report for two years.

 

• Rate Shopping: If you’re applying for a car loan and rate shopping (applying to multiple lenders to find the best rate), credit scoring models often treat multiple inquiries within a short period (usually 14-45 days) as a single inquiry. This minimizes the impact on your credit score.

 

The Benefits of Applying for a Car Loan

Despite the small dip in your credit score from a hard inquiry, applying for a car loan can have several benefits:

 

• Access to Financing: A car loan can help you buy a vehicle that you might not be able to pay for in cash.

 

• Credit Mix: Having different types of credit (like a car loan in addition to credit cards) can positively impact your credit score. It shows lenders you can manage various types of credit responsibly.

 

• Building Credit: Making regular, on-time payments on your car loan can help improve your credit score over time. This positive payment history can outweigh the minor impact of a hard inquiry.

 

Strategies to Minimize Impact

If you’re concerned about the impact of a car loan application on your credit score, there are a few strategies you can use to minimize the effect:

 

• Rate Shop Efficiently: Try to complete all your loan applications within a short period, ideally within 14 days. This way, multiple inquiries will be treated as one, reducing the impact on your credit score.

 

• Check Your Credit First: Before applying for a car loan, check your credit report and score. This gives you an idea of where you stand and allows you to correct any errors that might be dragging down your score.

 

• Limit Other Applications: If you know you’ll be applying for a car loan, try to avoid applying for other types of credit at the same time. This limits the number of hard inquiries on your report.

 

Managing Your Credit After Getting a Car Loan

Once you’ve secured your car loan, managing it well is key to maintaining and improving your credit score. Here are some tips:

 

• Make On-Time Payments: Ensure you pay your car loan on time every month. Late payments can significantly hurt your credit score.

 

• Pay More Than the Minimum: If possible, pay more than the minimum monthly payment. This reduces the loan balance faster and can save you money on interest.

 

• Monitor Your Credit: Keep an eye on your credit report and score. This helps you spot any issues early and take corrective action if needed.

 

At The End of the Day, it's Worth it

Applying for a car loan does have a small impact on your credit score due to the hard inquiry. However, this effect is minimal and short-lived. The benefits of securing a car loan, such as building your credit and having access to financing, generally outweigh the minor dip in your score.

 

By understanding how credit inquiries work and taking steps to manage your credit responsibly, you can navigate the car loan process with confidence. Remember, the key to a healthy credit score is making timely payments and managing your credit wisely. So, go ahead and apply for that car loan with peace of mind, knowing that the impact on your credit is minimal and manageable.