If you were torn between buying or leasing a car, you may have to look at criteria other than the potential impact on your credit score to make your decision. Despite the many differences between these two vehicle financing options, the effect on your credit score by either type should be roughly similar.
Whether you buy or lease your next ride, your credit score will be involved, because both a lease and a car loan are debts, or more specifically, installment debts, which consist of a fixed series of payments over time and are subject to being reported on your credit report. Your lender, in either case, will likely check your credit score to determine the interest rate to charge. This action will bring your score down a few notches. Specifically when leasing, avoid pushy tactics by the dealer to see your credit history, says consumer website Credit Repair. Early inquiries should be irrelevant to lease negotiation and can damage your report.
New Line of Credit
As a new form of debt in your overall credit picture, a car lease and a car loan could impact your credit score in multiple ways: Your overall debt will increase, which will change your debt-to-income ratio. While income does not appear on credit reports, installment loans such as leases and car loans do factor into the calculations that mortgage lenders, for example, make to determine your ability to pay back a loan. At the same time, a car lease or loan adds a different type of debt to the mix -- a recurring installment debt -- and this is a positive factor in determining credit scores.
However you slice it, if you're making lease payments or loan payments, your credit score will reflect how you manage those debts. If you consistently pay on time and are never late, your credit score will reflect your diligence; miss a payment or two, and your credit score could plummet. Given that the length of a car loan is generally longer than a car lease, a long-term loan could work for or against you: A longer history of payments presents more opportunity to demonstrate conscientious payment habits, yet that longer loan period could also prolong the payment of high interest rates, which could strain your finances and forestall credit improvements.
Defaults or Delinquencies
Delinquent or defaulted accounts are bad news for your credit score, whether for a lease or loan. If you cannot make your car payments, your vehicle could be repossessed by the dealership, which affects your report negatively. Surrendering the car voluntarily could also have undesirable repercussions: In the case of a lease, terminating early is a bad mark on your report. Voluntarily returning a loan-financed car does not erase the loan, and you could still be liable for the unpaid balance. Refinancing could also subject you to prepayment penalties, saddling you with more debt and credit doldrums.
- Cars Direct: How a Car Loan Payment Affects Your Credit Score
- Consumer Reports: Low Car Payments Can Hurt You
- Equifax. "How Credit History Impacts Credit Scores." Accessed Feb. 4, 2020.
- Equifax. "Understanding Hard Inquiries on Your Credit Report." Accessed Feb. 4, 2020.
- FICO. "Amounts Owed." Accessed Feb. 4, 2020.
- Experian. "What Is Debt-to-Income Ratio and How Do I Calculate It?" Accessed Feb. 4, 2020.
Timothea Xi has been writing business and finance articles since 2013. She has worked as an alternative investment adviser in Miami, specializing in managed futures. Xi has also worked as a stockbroker in New York City.