How Long Should I Keep a Car Loan to Build Credit? The Complete Guide

Getting a car loan can be a great way to build your credit history and improve your credit score over time. However, figuring out the optimal duration to keep the loan to maximize the credit-building benefits can be tricky In this comprehensive guide, we’ll walk through everything you need to know about using auto loans to build credit

How Do Car Loans Impact Your Credit?

Car loans are installment loans, so they are reported to the credit bureaus and become part of your credit profile. Here are the key ways a car loan can influence your credit

• Payment History: Making consistent on-time payments will build your credit by demonstrating responsibility. Missed or late payments can damage your score.

• Credit Mix Having installment loans like an auto loan contributes to a healthy credit mix which can boost your score.

• Credit Utilization: Car loans impact your overall debt load, so managing your utilization responsibly is key.

• Age of Accounts: Keeping the loan open longer grows your credit history depth, a factor in your score.

• Inquiries: Auto loan applications result in hard inquiries, which may cause a small temporary score drop.

So in general, responsibly managing an auto loan helps build your credit over time. But how long should you keep it?

When to Keep the Car Loan for Longer

In certain situations, it can be beneficial to keep your auto loan open for a longer period:

• If you have bad credit, keeping the loan 24-36 months demonstrates positive payment history and responsibility, boosting your score.

• If you have a short credit history, a longer auto loan builds up your thin file with a seasoned, active account.

• If you lack installment loan accounts, keeping the car loan diversifies your mix with this account type.

• If you only have a few open accounts, keeping the loan maintains your overall account quantity.

The longer you responsibly manage the loan, the greater the positive credit impact. However, financial considerations should also factor in.

When to Pay Off the Car Loan Early

While credit-building is important, you also want to be financially savvy. Here are some situations where an early payoff could make sense:

• If your auto loan has a high interest rate, paying it off faster minimizes costly interest charges.

• If you can get a lower rate through refinancing, that also saves money versus sticking with the loan.

• If you need to lower your DTI for a mortgage, eliminating the car payment may help you qualify.

• If you have excessive interest debt like credit cards, focus on paying those down first before putting extra money toward a lower-rate car loan.

• If you have a robust credit profile with established history, mix, and account quantity, the impact of closing the auto loan early is minimal.

As with any financial decision, pros and cons have to be weighed according to your specific situation.

General Recommendations

While there is no one-size-fits-all answer, here are some general guidelines on ideal auto loan lengths for credit building:

• If your credit score is fair or poor, try to keep the loan at least 2 years, ideally 3 years, to demonstrate responsible usage and payment history. This applies especially if you have limited other credit accounts.

• If your credit score is good or excellent, you may be fine paying off the loan earlier while still reaping credit benefits. Monitor changes using free credit checks.

• Aim for the shortest term manageable based on your budget so you pay less interest. For example, opt for a 3-year over a 5-year loan if the payment fits your finances.

Check your latest auto loan offers and rates so you can make an informed decision. Shop multiple lenders to find the best loan terms for your situation.

Other Tips for Building Credit with an Auto Loan

Beyond loan length, there are other ways to maximize credit-building with your car loan:

• Make payments on time each month to build positive history. Even one late payment can hurt.

• Pay more than the minimum when possible to reduce interest costs. Ensure extra goes to the principal.

• Consider making biweekly half-payments to pay the loan off faster.

• Refinance if you can get a significantly lower rate from another lender.

• Avoid excessive hard inquiries from loan shopping in a short timeframe to minimize score dings.

• Keep credit card and other debt balances low to maintain a healthy credit utilization.

The Bottom Line

Used strategically, car loans can build your credit. But you have to balance credit goals with financial considerations when deciding the ideal loan length. Factors like your current credit health, the loan terms, and your overall finances should steer your decision. Monitor your score as you manage the loan so you can track your credit-building progress.

The 20/4/10 rule is a guideline for car buying that suggests a responsible approach to financing.