Does financing a car affect your credit score in the UK?

When you are looking to borrow money—in the instance of car finance, for example—lenders will use your credit score to determine whether or not you are a trustworthy borrower. This is a three-digit number generated from your credit report history and a number of additional factors. The higher your credit score, the more likely you are to be accepted for a credit application.

A form of credit in itself, purchasing a car through finance can have a positive impact on your credit score. Whether the overall impact is positive or negative will depend on a number of factors, varying with which method of car finance you use to purchase your vehicle.

What does it mean to finance a car?

Although important for many, cars are often an expensive purchase, and not everyone can afford to pay out in one large sum. Car finance allows the buyer to spread out the overall cost across multiple months—and usually years—in order to make vehicle purchase more affordable.

Like most loans and credit agreements, car finance is not one-size-fits-all. There are multiple methods to choose from in order to find the option that best suits you.

• Car loan: This is when you borrow money from a separate lender to purchase a vehicle outright, and repay this money plus interest over the agreed loan term. You will own your vehicle as soon as you buy it, and avoid mileage and other restrictions that often come with alternative finance options.
• Hire purchase: When financing a car through hire purchase (HP), you will not be the legal owner of your vehicle until the last payment is made. Finance is secured against the car, and the cost is spread across the agreed loan term. You will have the option to return the vehicle to the dealership, or part exchange it, at the end of your loan term, however, hire purchase is usually undertaken with the intention of keeping the car at the end of the contract.
• Personal contract purchase: Similarly to hire purchase, if you choose to finance a car through personal contract purchase (PCP) you will have the option to return it at the end of the term. The difference is that with PCP, the devaluation of the car is factored into the size of the monthly payments, meaning this option may be cheaper month-on-month. If you do decide to keep your car, however, the sum of your final payment will be large—PCP is a good option if you are not planning on keeping your vehicle at the end of your term.
• Conditional sale: This works with the same process as hire purchase, without the option to return the car at the end of the agreed term. You will own your vehicle outright at the time of final payment.

Each of these methods of car finance will differ in how directly they influence your credit score, but the overall end result is likely to be consistent as long as repayments are made and other factors are taken into account.

Positive impacts of car finance

When purchasing a car on finance, if certain things are carried out correctly you will likely see a gradual increase in your credit score. It won’t improve overnight but, as long as the following key considerations are followed, you should see a positive impact.

• Keep up with your monthly repayments
• Repay the full loaned or credited amount by the end of the agreed term
• If you already have some form of credit—a credit card, for example—taking out a different type of credit in the form of car finance creates a ‘credit mix’ which can be good for your credit score as long as you successfully manage repayments for each

The advantage you gain from improving your credit score through car finance is that any future credit applications you make may be more likely to be accepted. Financial stability and freedom become more achievable.

Negative impacts of car finance

Of course, like any form of borrowing, there are a number of things that may cause a decline in your credit score when you buy a car on finance. Most are preventable, and so it is important to be aware of the potential impact these things may have before you consider financing a car.

• Hard credit checks: If too many “hard checks” are carried out on your credit report when searching for car finance, this can negatively impact your credit score
• Missing or late repayments: Missing or late payments on any kind of credit will cause a decline in your credit score, and car finance is no exception to this—repayments should be made on time each month in order to prevent this
• Defaulting on your loan: If you do miss a repayment, your lender will give you a set amount of time—usually 30 or 90 days—to make this payment before you default and your account is handed over to debt collectors. This could cause a number of subsequent financial problems, and your credit score will be negatively affected. It’s worth bearing in mind that, if the finance is secured against the car, the finance provider will also repossess the car to recover their costs
• Being unable to afford your loan: If you cannot afford to pay back this loan, you may fall behind on other bills. These late payments in turn will negatively impact your credit score—always ensure you have budgeted for the cost of repayments before you finance a car

One of the most common causes of bad credit when it comes to car finance is missed or late payments. It can be easy to think a day or two won’t matter, but falling into the habit of missing repayments can be very detrimental to your financial health.

You will be given a grace period in which you have the chance to make a late repayment without consequences. If you still fail to pay, however, evidence of this can be present on your credit report for up to seven years.

Before you take out car finance, ensure you can afford the monthly repayments.

As well as additional fees and early settlement implications, your credit score may be impacted if you choose to end your car finance term early. You may choose to settle early due to any number of factors—you can no longer afford the repayments, or can now afford to pay in one large sum, for example.

It may feel like the most beneficial thing for you to no longer have these repayments to consider each month, and in most cases your credit score should not be negatively impacted. If, however, you repeatedly take out finance or loans and settle them before the agreed term, your credit score could take a hit.

It is an additional cost for lenders each time you decide to settle your finance early. If you are seen to be doing this repeatedly, it may be a detriment to your credit score and any future credit agreements you wish to take out.

In short, car finance can affect your chances of taking out a mortgage. By building up a history of regular repayments being made in full and on time, you may increase your chances of being accepted for any large credit agreements, including mortgages. It is not a direct influence, but rather a potential domino effect.

On the other hand, when considered in terms of affordability during a mortgage application, car finance will be factored into how much disposable income you have. Mortgage lenders may offer to loan you a smaller amount if you are already repaying large debt amounts each month (car finance is technically classed as a debt). You can reduce the risk by paying off your car finance before you apply for a mortgage.

Although there is no official minimum credit score in order to be eligible for car finance, you are more likely to be accepted with a stronger score. Applying with a low credit rating may mean you are offered finance at a higher interest rate, meaning monthly repayments may be higher, as well as the overall amount owed.

If you are not eligible for car finance, or can’t afford the interest rates offered, you could consider a guarantor loan. This alternative option could be the best way to access the finance you need, without accruing too much interest.