A motorcycle loan is an excellent example of this. The purchase price for a bike is low, so approval chances are better. Paying the loan off can build credit.
Understanding how this happens requires knowledge of how the credit scoring system works. One of the variables used in calculating a credit score is called “payment history.” It basically tracks payments, rewarding those who make them on time. It’s worth 35% of the total credit score, so it’s a big deal, but that’s not the only way that financing can build credit.
How is your credit score calculated?
Payment history: Payment history is the largest variable in the credit score calculation. This is the record of all payments that have been made.
Amounts owed: The next most important one is called “amounts owed.” It’s worth 30% of the overall credit score. When a consumer first takes out a loan, the amount owed will be the entire loan amount. As payments are made, that amount comes down, and the amount of available credit goes up.
Length of credit history: Next on the list is “length of credit history,” which is worth 15% of the score. A motorcycle loan will affect that only if it’s the first credit account opened by the buyer.
Credit mix: The loan will also affect a person’s “credit mix,” which is worth 10% of the score. Most consumers hold a credit card or even a mortgage. A motorcycle or personal loan falls in a different category, improving the mix.
New credit: The fifth variable, called “new credit,” affects the buyer negatively when they finance a motorcycle. It counts as a new account, which will cause the credit score to drop slightly. That effect is only temporary, though, so it’s of little concern. The other variables in the credit score calculation are far more critical, thus the higher weighting.
How long does it take to improve credit?
Building credit is a slow process. Each on-time payment needs to be recorded by the lender and then reported to the credit bureaus. Some lenders do this monthly. Others send their reports in less frequently. There’s no regulation on this, so the timing is completely up to the lender. The credit bureaus move slowly also. Consumers should not expect scores to go up quickly.
The best way to look at this is to expect that credit will improve when the motorcycle loan is fully paid off. Credit scores will go up slowly, but they will go up. It’s also good to limit applying for other loans or credit cards until the loan is paid in full. Those actions will bring a credit score down, not increase it.