Find Out Why Car Shopping Can Hurt Your Credit

by | Jul 15, 2020

Does Car Shopping Hurt Your Credit?

About two weeks ago, my 2007 Nissan Altima shit the bed and proved more costly to repair than it would be worth.

I knew it was time for a newer car, and I immediately started looking.

A few days later, I ended up at a Ford Dealership to look at a 2017 Hyundai Sonota, which had recently been included as part of a trade-in.

All told, the car’s listed price was $16,500, which was in my price range. I wanted to do half down, half on financing in order to continue building my credit.

So, I went ahead and applied for financing options just to see what I was approved for.

A few days later, while I was still in the car buying process, I got an email from CreditKarma, which I use to keep track of my credit score.

“Sukesh, your score dropped”

Oh shit, I thought to myself. What could have happened?

In my account, I saw something called hard inquiry (also known as a hard pull), which seemed to drop my credit about 4 points.

Okay, so it wasn’t too bad.

I ended up buying the Sonota a few days later, after several more long ass loan applications (seriously, does anyone enjoy these?), but my credit remained steady.

So, what happened exactly?

First Things First, What Is A Credit Score?

Raise your hand if you’ve heard of your credit score. Now, keep your hand raised if you understand how that score is given and what it means.

If you’re like me, you put your hand down on the second statement.

Now I think we all know that when someone is talking about car shopping hurting their credit, that they’re talking about their credit score.

A credit score is a number between 300 and 850 that tells lenders how likely you are to repay the money you borrowed. The higher your credit score, the more likely you are to repay what you borrow.

Your credit score is based on your credit history, which measures:

  • Your payment history, which is the total amount of payments you’ve made on time. This is the most important factor.
  • How much of your total credit limit you are using (the total amount you can borrow vs. the amount you have borrowed)
  • Any collections, judgments, tax liens, or civil judgments on your report
  • The average age of your credit, or how long you have been borrowing for.
  • The total number of accounts. This includes things like loans, credit cards, and repayment plans.
  • The number of hard inquiries or applications to borrow money. This is the factor we will talk about today.

There are a number of different scoring models, but the most common is the FICO, which was invented by the Fair Issac Corporation.

Credit: Experian

There’s also the VantageScore, which was developed by the 3 major credit card bureaus, which are listed below.m

Credit: Experian

They are:

  • Equifax
  • Experian
  • TransUnion

Each of these bureaus keeps a file on you, which contains your personal information, your credit account history, all the request for credit you’ve made, and your public records.

All this boring stuff is pretty important, however. Assuming you’re not paying cash for the car you want to buy, you’re going to need to apply for credit.

And for that, your credit score matters.

Why Does Your Credit Score Matter?

Imagine you have 2 neighbors, Ted and Bill. Ted, you’ve known for years. He’s an alright guy, but whenever you lend him things, they mysteriously disappear.

Your other neighbors also seem suspicious of lending their things to him.

You hear rumors that Gertrude, the sweet old grandmother at the end of the block lent Ted her favorite lawn gnome Sally, only to have her go missing days later.

Meanwhile, Bill just moved into the neighborhood a few months back. After being burned by Ted, you’re reluctant to lend him anything.

But, you hear that some of your other neighbors have lent him things.

Even Gertrude was satisfied after he returned her second favorite lawn gnome, Steve.

One day, Ted comes to your house and asks to borrow your lawnmower.

Now, this isn’t just any lawnmower,

Cutting grass never looked so sleek.
Credit: SLE Equipment

It’s the Toro 74090 Z Master 7500 96″ Zero Turn Mower 38HP Kohler EFI.

And you bought this bad boy for $33,000.00 new.

But, you decide to lend the mower to Bill. Everyone else in the neighborhood can vouch for him.

And, like clockwork, 6 hours after you lend him the mower, it’s returned to you, completely clean, with a six-pack of beer on the seat.

Two days later, Ted and Bill both come to your house and ask to borrow your power washer.

You can only lend it to one of them, so which one are you lending it to?

Lending it to Bill is probably the best choice, right?

This is an extremely simple example of the principle behind your credit score. Your credit score at it’s most basic, is a measure of how financially trustworthy you are.

If you were lending money, Ted would have a low credit score, while Bill would have a high one.

Bill, in other words, is more likely to pay you back, so you’re willing to trust him with more.

For lenders, credit scores are decision-making tools they use to anticipate how likely you are to repay your loan.

Now, assuming you’re not buying your next car with cash, you’re going to need to apply for credit when you’re shopping around.

This is when having good credit comes in handy, because the better your credit is, the better your chance of qualifying for the best loans.

Depending on the loan you qualify for, the savings could be hundreds or potentially even thousands of dollars.

A good credit score can also help you with:

  1. Getting approved for credit cards with the best rewards and perks.
  2. Negotiating lower interest rates on your credit cards and on loans.
  3. Getting a higher limit for your loan or for a credit card.
  4. Getting easier approval for renting a house or an apartment.
  5. Accessing the best car insurance rates.
  6. Buying a cell phone on a contract with no security deposit.
  7. Not needing a security deposit when you turn on the utilities at a new place.
  8. Getting into a new job, as some employers check your credit during the hiring process.

So, Why Does Car Shopping Hurt Your Credit?

To be clear, car shopping will only hurt your credit if you apply for credit. If you don’t apply for credit, nothing will happen to your credit score.

With that being said, do you remember those credit bureaus I told you about earlier?

The 3 main ones are:

  • Equifax
  • Experian
  • TransUnion

These guys are masters at assessing the risk that you won’t pay back what you owe – and according to FICO research, the more credit accounts you open in a short period of time, the higher your risk.

There are two types of credit checks, the soft pull, or the hard pull.

Soft Pull: Soft pulls do not affect your credit score. A soft pull is when you or someone else looks at your credit report, even if you don’t apply for credit.

Hard Pull: A hard pull is when your credit is reviewed as part of a decision-making process for a loan or another type of credit. Each hard pull typically won’t affect your credit by any more than a few points.

When you’re car shopping and you want to see your credit rates, you can apply for a loan and the dealer will run your credit.

What Happens When The Car Dealership Runs Your Credit?

When you authorize the dealership to run your credit, they send a request to the credit reporting bureaus to see your credit score.

Does The Car Dealer Have To Give You A Copy Of Your Credit Report?

Even though the dealer is running a report on your credit, they are not required to give you a credit report when you are agreeing to loan terms.

You may ask for one, and some dealerships may give you a copy, but this isn’t something that is required.

Before you go car shopping, you can take advantage of a free credit report from annualcreditreport.com.

You can also use a service like CreditKarma, which is what I personally use.

When The Dealer Pulls Your Credit, It’s Considered A Hard Pull.

Unfortunately, a hard pull will decrease your credit score. There’s no way to avoid that.

There is some good news though.

Auto loans are treated differently than credit cards are on your credit report.

For example, if you apply for 6 different credit cards in a 30 day period of time, the 10% of your FICO score that is determined by hard inquiries can take a hit.

This is because FICO research has shown that people with 6 inquiries or more on their credit report can be up to 8 times more likely to declare bankruptcy than people with no inquiries.

In other words, the more accounts you have, the more likely you are in desperate financial straights and won’t be able to pay back what you owe.

If you are car shopping like most people, however, you won’t see more than a 5 point dip to your credit score at most, because credit bureaus have realized that their models are more accurate when auto loans are reported differently.

Shopping Around For Auto Loans Won’t Lower Your Credit As Much As It Will For Credit Cards

Credit Bureaus do treat “rate shopping” for mortgage, auto, and student loans a bit differently than they do other types of shopping.

For example, FICO ignores inquiries made in the 30 days prior to scoring. If you find a loan within 30 days, the inquiries won’t affect your scores while you’re rating shopping.

FICO recommends that you do your rate shopping within a focused period, such as within 30 days. Your FICO score will distinguish between a search for a single-car loan and a search for many new lines of credit.

When you look for new credit, only apply for and open new credit accounts as needed. And before you apply, it’s good practice to review your credit report and FICO Scores to know where you stand. 

In other words, while you’re car shopping, make sure you’re not extending the search process of many months where you’re applying for multiple loans during the process.

Which means…

Even If The Dealership Runs Your Credit Multiple Times, Your Credit Won’t Suffer

When I was in the midst of buying my Sonota, the dealership I was at accidentally ran my score twice.

According to the agent I was working with, this kind of thing happens a lot.

The first was when I came in and was negotiating, and again when I returned to actually sign the paperwork.

At first, I was pissed. I thought they had lowered my credit score for no good reason. Only, my credit didn’t dip like I expected.

As I mentioned earlier, it dipped 4 points despite the dealership running my report twice.

Again, that’s because multiple hard pulls for a car loan are generally treated as one inquiry, instead of multiple inquiries, which means your credit score will only go down by a few points.

So, assuming your car dealership runs your credit twice within a 30 day period, you’re going to be just fine!

Although you can’t have an accurate hard pull removed from your credit report, if the dealer pulled your credit in error or without your permission, you can ask the credit bureau to remove the hard pull.

But, you don’t really need to do that unless you really want to, because the impact is very small compared to other factors.

So don’t stress out. Even though your score may dip a bit initially, hard credit pulls aren’t forever.

Hard Pulls Only Affect Your Credit Score For 12 Months

Hard pulls remain on your credit report for 2 years, but they only really affect your credit for the first 12 months.

But here’s the thing, their impact lessens over time. Even if you have multiple hard pulls in the span of a few months, potential lenders probably aren’t going to care that much.

It’s more important that you have a track record of on-time-payment and a low credit utlization ratio.

So no worries.

Now, if you do buy the car you’re applying to get credit for, you’re likely going to see some bigger changes to your credit score.

How Much Will A Car Loan Drop Your Credit Score?

While it’s easy to say how much your credit will drop from a hard pull, it’s not so easy to figure out how a car loan will affect your credit score.

Because at the end of the day, figuring out how much a car loan will drop your credit score is a bit of an inexact science.

We already know that as part of the loan approval process your credit score will drop, normally by less than 5 points or so.

But what about the loan itself?

If you recall, there are 6 factors that make up your credit score.

  1. Your payment history, which is the total amount of payments you’ve made on time. This is the most important factor.
  2. How much of your total credit limit you are using (the total amount you can borrow vs. the amount you have borrowed)
  3. Any collections, judgments, tax liens, or civil judgments on your report
  4. The average age of your credit, or how long you have been borrowing for.
  5. The total number of accounts. This includes things like loans, credit cards, and repayment plans.
  6. The number of hard inquiries or applications to borrow money.

Keeping those factors in mind, we can broadly say that if you’re making a low down payment on your car (less than 50% or so), you will probably see a credit decrease.

This is because taking out a new loan will increase your credit utilization rate if you have a large balance on it.

For example, let’s say you have $3,000 in credit card debt on a card with a $10,000 dollar limit. You then take out a car loan for $15,000 dollars.

Before the car loan, your credit utilization was 30%. After the car loan, it becomes 64.2%.

As you can see, a 30% credit utilization is considered fair, however, a 64% utilization rate is poor.

In this case, your credit score would drop when you get the loan.

However, it is possible for your score to go up when you buy a car.

A car loan is reported to the credit bureaus as an installment account. Part of your credit score comes from your credit mix, which means the different types of credit you currently have.

If you don’t currently have an installment account (like student loans, or a mortgage) then getting a car loan can boost your credit.

Once You Start Paying Off Your Car Loan, Your Credit Will Increase

While getting a car loan may decrease your credit score initially, you have a great opporitunity to boost your score by paying the loan off.

The most important factor for your credit score is your payment history. By paying your loan payments fully, and making sure they are on time, you can help boost your score.

Often times it will only take about 2-3 months of consistent payments for the initial score ding from the hard credit pull to be mitigated by the impact of paying your payments on time.

So don’t sweat it.

Buying A New Or Used Car? Protect It The Right Way.

Now I know how stressful buying a new car is. Trust me, I was thrilled when the sale paperwork was done and I drove off with my new Sonota.

What I wasn’t thrilled about was the potential that I would have to pay for a potentially catastrophic engine failure.

Hyundai is known for having engine problems, starting with the infamous engine issue on their 2011 model year cars that caused them to extend their engine warranty in some cases.

I didn’t want to potentially have to pay upwards of $6,000 for a new engine, or $4,500 for a used engine.

Now obviously I’m probably biased. I work for Protect My Car, after all.

But I still chose them to protect my new Sonota, even over the dealer warranty.

The fact is, a vehicle service contract from Protect My Car pays up to $15,000 dollars worth of repairs, including for engine failure as I previously mentioned.

I also get access to 24/7 roadside assistance, as well as a ton of free rewards every month, including deep discounts on takeout and electronics from Amazon.

That’s not to mention that I get free oil changes and tire rotations for as long as I have the policy.

Better yet, I pay about $2 dollars a day. That’s less than it costs for a cup of coffee. $2 a day for peace of mind?

Worth it.

If you end up getting a new car, make sure you choose a vehicle service contract from Protect My Car. To see how much you could save, just click the button below to get a free quote.

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