I am looking to buy a used car. I have enough saved to pay cash for the one I want — $10,000. But I've heard having a car loan on your credit reports can be good if you pay on time. I don't really want to pay interest, and I prefer to pay cash up front for things (although I have three credit cards because I know that's good for my credit), but do you think I should get the loan? My credit score is 750. – Benjamin
First ask yourself how good you really want your credit to be — and why you need it to be so good. With a FICO score of 750, you already are over the 740 FICO score needed to qualify for the best interest rates on auto and mortgage loans.
So, is it worth the hassle to take out a car loan just to add points to your FICO score? Probably not. Your credit score is a means, not an end. For some people, it becomes a hobby or an element of pride to get their score as high as possible. That's fine, of course, but if you “just” want to have a good enough credit score to benefit from the best loan rates available, you're already there.
While taking out a car loan can add to your credit score, the effect will likely not be that large. In addition to boosting your good payment history (assuming you pay on time), a car loan will add to your credit mix, which makes up 10 percent of your FICO score. A car loan is an installment loan, while credit cards are considered revolving loans (with revolving balances). Credit scoring models like to see a mixture of both, as it proves that you can juggle a variety of credit types. Because credit mix is a relatively small percentage of your FICO score, however, this single car loan's effect on your score won't be much.
You'll have to take a few things into consideration when deciding whether to finance a car. First and foremost, of course, is the cost of the car loan. Why pay interest on a loan if you have cash at hand? While auto loan rates are low for people with excellent credit (below 4 percent at current rates), that still adds up. For example, over a three-year loan, you could be looking at several hundred dollars in interest over the life of the loan.
Second, if you buy a used car, you could find yourself with a loan underwater if you decide to sell that car and get a new one before the loan has been paid off. Car prices are considerably lower when selling or trading in, so you might be left holding the bag and paying money on the loan.
You do have one more option – paying a significant amount down and then getting a loan for a smaller amount. But, even then, you're paying interest you don't have to pay – just for small boost to your credit score.
The only reason getting a loan may be a wise move is if you need that $10,000 for something else – to bulk up your emergency fund, for example, or pay down other high-interest debt. But it seems as if your financial life is in pretty good shape because you didn't mention any problems — and because your credit score is so good.
So, Benjamin, trust your instincts. If you don't feel that taking out a car loan is a good fit for you, don't. You clearly have a good gut feeling when it comes to how to manage your money — and that is already reflected in your excellent credit score.
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