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Personal loans have grown significantly in popularity due to their accessibility and flexibility. They have become essential for individuals seeking to meet their immediate monetary needs.
However, the impact of taking out a personal loan on one’s credit score is often overlooked. Understanding how personal loans affect credit scores is crucial for borrowers to make informed decisions and maintain a healthy financial profile.
In this blog, we will explore how personal loans can affect credit scores and offer insightful advice on mitigating their adverse effects.
Table of Contents
What Is a Credit Score?
A credit score is a numerical value ranging from 300-900 and is determined by factors such as loan history, credit history, and repayment behavior. Lenders use credit scores to evaluate the creditworthiness of borrowers and decide on interest rates and terms of credit or loan offers.
How Can a Personal Loan Negatively Affect Your Credit Score?
Here are some ways in which a personal loan can negatively affect your credit score:
Hard Enquiries on Credit Report
Applying for a personal loan requires a hard enquiry on your credit report by lenders to assess your creditworthiness. While a few enquiries may not affect your credit score, multiple enquiries can have a detrimental effect. To protect your credit score, it is recommended to research and select reputable lenders that offer benefits like low-interest rates, flexible repayment terms, and a hassle-free application process.
Taking Up Too Many Debts at Once
Consolidating debt is one of the primary benefits of a personal loan, as it enables borrowers to replace high-cost debt with a lower-cost option.
However, using a personal loan to add to existing debt rather than consolidate it may be considered irresponsible financial behaviour and harm your credit score.
It is important to approach debt consolidation with a responsible mindset and a clear plan for repayment to ensure a favorable impact on your overall financial health.
Missing A Loan Payment
Although missing a personal loan repayment by a few days won’t lower your credit score, any payment that is overdue by more than 30 days will be reported to the credit bureaus and cause significant damage to your credit rating.
Therefore, creating a budget that includes all your debt repayments, including your personal loan, is essential to avoid missed payments and experience better financial health.
Additional Fees
Aside from the interest charges, borrowers must also consider additional costs associated with a personal loan, such as origination or late fees. These costs can increase the overall debt burden and lower the available credit limit.
This, in turn, increases the credit utilization ratio, which is a crucial factor in determining the credit score. You may consider borrowing a little extra to cover these costs so you do not have to dip into your savings or other funds to pay them separately.
Tips For Improving Your Credit Score Through Personal Loan
Below are a few suggestions to enhance your credit score using a personal loan:
Timely Repayments: Making prompt payments demonstrates responsible credit behaviour and boosts credit scores, particularly for unsecured personal loans.
Build A Credit History: If you have never borrowed money, you may not have any credit history. Consider taking out a personal loan as a starting point for building your credit history. This can establish a positive credit record over time, boosting your creditworthiness and making you more attractive to lenders. Moreover, you can also apply for a credit card and use it responsibly to improve your credit score over time.
Reduce Load On Credit Card Limits: Maxing out your credit card limit might harm your credit score. Opting for a personal loan to pay off your credit card balance can be a smart move to boost your credit score.
Conclusion
The use of a personal loan can have either a positive or negative effect on your credit score. It is imperative to uphold responsible financial behaviour, which includes borrowing only within your means and ensuring timely EMI payments. It is recommended to conduct extensive research and compare various lenders to select the most suitable loan option based on your requirements.
Apply today for a personal loan and obtain the necessary funds promptly!
