Navigating Loans, Tackling Debt, and Credit Scores | NerdWallet

Hi, I'm Sean, a finance nerd. And today we're going to talk about how paying off your student loans might impact your ability to get an auto loan. And I'm joined in this conversation by my co-host, Sarah Rathner, and a listener, Say, who lives in Minnesota. Say, welcome to Smart Money. Hi, thank you for having me. I'm excited to listen and hear everything you all have to offer for me as I think about my decision. Of course. So Say, before we get into the conversation, a quick reminder that we're not here to give you individualized personal finance advice. Our goal is to give you the information that you need so you can make the most informed financial decision possible for your situation. So one thing that strikes me is that your question is really a question about timing as well. You're trying to figure out when to get an auto loan as it relates to paying off your student loan. Should you get the auto loan before or should you wait until after you pay off your student loan? It seems like you're concerned about getting the auto loan after paying off your student loan because of the potential dip to your credit score. So currently, what are you thinking about timing? Do you need a new car in the coming six months or so? Could it last you a little bit longer? What have you thought about that? Yeah, no, that's a great question. I think it could last a little bit longer. I think it just feels a little inconvenient for my current job, right? Because it's a smaller car and I have a job where we go tabling and do different events and we need to have more space and so, but obviously there's other solutions around that as well. And definitely waiting a little bit longer sounds like the more financially responsible thing to do and probably better timing as well. I do wanna just quickly touch on general credit building tips as well, since it seems like that's something you're interested in. We know at NerdWallet that tried and true tactics like making on-time payments, that's the single biggest factor that impacts your credit score. So continuing to do that on your credit cards, your student loans when you're still paying them off and your future auto loan will be able to enable you to have the best credit score that you can going forward. You might wanna also consider setting up something like AutoPay so that you don't miss your due dates. Taking on a new debt can be a little overwhelming sometimes when you have another due date, another payment to make each month. So AutoPay can really help with that. And also in general, there are products that can help you build credit. It seems like you may be beyond that. So if you know someone who's just beginning to build their credit for the first time, something like a secured credit card or a credit builder loan can be really beneficial in this space. NerdWallet happens to offer both a secured credit card and a new credit builder loan called NerdBuild. And there are a lot of other great companies that offer those as well. And we'll have a link in our show notes post about how you can use products to build your credit. You know, when we talk about how paying off a debt can potentially dip your credit on temporarily, but many people do notice a drop in their credit score when they pay off a debt and get it off of their plate. And I mean, we would like to acknowledge how cruddy that feels because you're doing everything right by paying down debt. And then it feels like you're getting penalized for it instead of rewarded. And so let's talk a little bit about why you might see once you do pay off your student loan, and then in the future, if you have an auto loan, once you pay that off, once you pay off credit card debt, why you might actually see the unexpected happen, which is that your credit score takes a bit of a dip for probably about a couple of months. And that's because one of the factors that goes into calculating your credit score is what's called your mix of credit. And that's where you have a mix of what are called revolving debts, which is credit card, which is a debt that you can continue to add onto while you're paying it off. And then also installment loans, kind of like a student loan or an auto loan where you borrow one sum of money, you don't add onto it, you just simply make payments toward that loan until it's paid off entirely. And lenders kind of like to see that mix. And so when something comes off of that list, they knock you down a little bit, and then you move on from it. And so it is a little bit of a mystery how that works. Credit score calculations, they kind of happen in this black box. And it's not a knock on your character or who you are or that you've done the wrong thing. It's merely just how the math shakes out. So I would say to anybody who's in this situation, you might be in this situation, say in the near future, just know that this is not a permanent drop. You have made a financial move that could benefit you in the long term by getting this debt off of your plate. And credit score is one financial factor that's considered when you're looking to borrow additional money for some purpose. It's not the only thing that's taken into account. Other financial information is also taken into account as well. And if you're looking for a loan, it's helpful to shop around and maybe compare a couple of different options. NerdWallet has great comparison tools for this, but you can look at banks, credit unions, online lenders. And when you walk into, say, a car dealership, you're already armed with information with a loan pre-approval. So when the dealer offers financing, you come from a really strong negotiation point. Well, I wanna get into car buying in just a moment, but one thing I wanna add on to what Sarah mentioned around what's going on with your credit score behind the scenes is that it can be helpful to remember that even though you are the one paying off this loan and your credit score may change accordingly, in some ways, it's not about you. It's about what lenders wanna see from potential customers. So back when credit scores were first created, we consumers were actually never supposed to see them. They are for businesses to understand how risky they think we might be to lend to based on previous credit data. So when something like a loan is no longer active on your credit report, you have fewer data points coming in. As a result of that, it can be harder for them to estimate your riskiness. It's nothing about you. So I always try to have a certain level of remove from the number of my credit score, what it is today and how I am behaving as a consumer, doing the best that I can on a daily basis to keep it in good shape. So let's talk a little bit about your potential new car. Let's start really broad and just tell us a little bit about what kind of car are you thinking about shopping around for? Yeah, yeah. Feels amazing to be like, let me just dream. Yeah, this is the fun part. This is like an ideal world. What car just lands in your driveway or your parking spot or in front of your house or whatever? A car with wings, no? Yeah, a jet pack. Yeah, yeah. Some teleportation device. I've been looking at smaller SUVs. So I'm actually a lot shorter. So driving a big car is scary for me. But like I said earlier, I'm needing to be able to transport more things than my little car. And so I've been looking at the midsize, smaller SUVs, you know, like a CRV or even like looking at Mazda, you know, Mazda 6, Mazda 7, those have looked really nice too, RAV4. So I'm kind of looking at that kind of car. And I do want it to be a little bit newer because I want it to last me longer. And so anything in like the 2020s and above. Okay, but potentially a used car, right? Yeah, used car, maybe a new car. I'll go test drive a couple of those just to see something that'll last me longer. As we all know, buying a new car, the idea of buying a new car can be extremely exciting and it can be really easy to get caught up in the momentum of it. So I always like to urge caution and say, before you go into the dealership, know how much you want to spend. Really before you even shop at all, because it's so easy to buy a car that's more expensive than you can really afford. And you might just fall in love with the car on the lot or maybe even get pressured into taking on a larger loan than you want at the dealership. So get really clear on that with yourself, play around with your budget like we discussed earlier and have an understanding of what total amount of car you would want to buy. And then think about what that might mean on a monthly basis. A lot of dealerships will actually put their financing in terms of monthly only, but then they extend it out for months and months and months and you end up paying a lot for a car loan over its entire term. So be really mindful of that too. And like Sarah mentioned earlier, it's generally best practice to get pre-approved for a few loans before you choose which one to go with. And if you apply for loans within about a two-week span, all of those quote-unquote hard inquiries where the lenders are looking into your credit profile will be effectively bunched together as one. So it'll just have a less serious effect on your credit score. Doing this before you go into a dealership gives you so much leverage in negotiations because they might be able to actually offer you a better rate on the loan than what you got from somewhere else. And they might know that you have other options to choose from. So you have more cards in your hand at that point. Thanks for watching. I'm Sean Piles, host of NerdWallet's Smart Money Podcast. If you learned something new today, hit like and subscribe and share with your friends. Also, listen to NerdWallet's Smart Money Podcast wherever you get your podcasts.