Building credit with a car loan, and how it goes the other way

A credit file is built out of accounts, and most Canadian files are built out of one kind: revolving credit. A card, maybe two, maybe a line of credit. That produces a thin file even when it is a clean one, and thin files are harder to lend against than people expect.

A vehicle loan is an instalment account, which is the other kind, and adding one changes the shape of a file rather than just the length of it.

What an instalment account adds

Three things, and they are worth separating because they arrive on different timelines.

A different account type. Credit scoring models look at the mix of account types on a file. A file with revolving credit only is missing a whole category, and adding an instalment account fills it. This one registers almost immediately, as soon as the account reports.

A payment history with a fixed shape. An instalment account has the same obligation every cycle for the life of the term. There is no minimum-payment ambiguity and no balance that drifts. Twelve consecutive on-time payments on an instalment account is an unusually clear signal, and clarity is most of what a thin file is missing.

Length of history, eventually. Terms on vehicle loans run for years, so the account ages and keeps aging. Average age of accounts is a real factor and there is no way to accelerate it. An account opened now is worth more in three years than it is worth now, which is an argument for opening it now rather than later.

The first way it goes the other way

Late payments.

An instalment account reports every cycle, and the same clarity that makes on-time payments legible makes missed ones legible. A revolving account with a small balance and a missed payment is noise. A missed vehicle payment is a rating downgrade on the exact account type the file was thin in.

Canadian files rate accounts R1 through R9. Thirty days late moves an account off R1. Ninety days late puts it well down the scale, and the entry stays on the file for six years from the date of last activity whether or not it is brought current afterwards.

The rule that follows: if a payment is going to be missed, the call to the lender happens before the due date, not after it. Lenders have deferral and rearrangement options that do not exist once an account is already reporting late, and they have no reason to offer them to someone who has stopped answering the phone.

The second way it goes the other way

Being upside down for longer than you planned to keep the vehicle.

A financed vehicle loses value on a curve that has nothing to do with the amortisation of the loan. Early in a term, the balance owed is usually above what the vehicle would sell for. That gap is negative equity, and it closes over the term as the balance falls faster than the value does.

This has no effect on a credit file by itself. It becomes a credit problem at the moment you need to get out of the vehicle before the gap has closed — a job change, a move, a family that grew. The options at that point are to keep it, to bring cash to close the gap, or to roll the gap into the next loan. The third is the one people take and it is the one that compounds.

A longer term makes payments smaller and makes this gap last longer. That is the trade-off, stated plainly, and it is the single most useful thing to understand before signing anything. The car loan calculator will draw the gap against a term you are actually considering, which is easier to argue with than a paragraph.

What a thin file looks like to an underwriter

Not bad. Unreadable.

A file with two years of history and one account has almost no information in it. A score is generated, and the score means less than it would on a file with a decade of accounts behind it, because there is very little for it to be computed from.

That is why applications from thin files lean harder on things outside the credit report: time at the current job, time at the current address, income that can be documented, and whether there is a down payment. Those are the inputs doing the work when the credit file has little to say, and the first two of them are the subject of how long you have been at your job.

The sequence that works

1. Get the account opened on terms that are actually affordable at the payment level, not at the maximum you would be approved for.
2. Set the payment to come out automatically, on a date shortly after income arrives, and leave it alone.
3. Do not miss one. A perfect twelve months is worth more to the file than any other single thing available to you.
4. Leave older revolving accounts open even if unused. Closing an old card shortens average account age, which is the one factor that cannot be rebuilt quickly.

That is the whole method. It is slow, it is boring, and it works — which is roughly the opposite of how credit repair is usually sold.