When buying a vehicle, a buyer can finance the purchase in a number of ways. For older, less expensive cars, a buyer may choose to pay in cash. However, when buying more expensive vehicles, a buyer will often choose to take out of a loan. While purchasing a vehicle with cash will generally not affect a person's credit score, taking out a loan will -- like all new loans -- affect the borrower's credit score.
Credit Scores
Credit scores are determined using information contained in a person's credit report. The credit report, compiled by credit reporting agencies, contains information related to the borrower's credit history, including his payments on past loans and any debt outstanding. No information about large purchases is entered in the credit report if the purchase is made without credit. For this reason, the purchase of a car without credit will have no effect on a credit score.
Car Loans
When a person takes out a loan to purchase a car, she gets the loan from a finance company. The finance company pays the dealer of the car and then requires the car buyer to pay back the cost of the car in a series of regular payments, plus interest. This loan, as with most other kinds of loans, is reported to a credit reporting agency. Depending on the person's credit history, this loan can affect the borrower's credit score in a number of ways.
Immediate Effects
Generally, the more debt a person takes on, the lower her credit score will go. This is because credit reporting agencies base a person's score on the perceived likelihood that she will pay back loans. The higher a person's ratio of outstanding debt to available credit, the lower the person's score. For this reason, a car loan will lower a person's credit score, at least temporarily.
Long-Term Effects
Although taking out a car loan may lower a person's credit score in the short term, successfully paying off the car loan can actually improve his score over the long term. This is because credit scores are also based on a person's history of repaying debts. If a person has a record of paying debts on time and in full, his score will improve, as it suggests the borrower is more likely to pay off future loans as well.
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