Does a Personal Loan Impact My Credit Score in 2022
Nowadays, the main emphasis on the credit score of the borrowers who take a personal loan is considered as a crucial factor by the lender. As a result, many young working professionals and the self-employed are looking for ways to improve their credit before taking out a personal loan. A personal loan is a type of loan that can be used for several reasons, such as buying an electronic device, consolidating debt, or renovating a home, which is an example of a personal loan.
What is a credit score?
To know how a personal loan affects your credit score, you first need to understand your credit score and how things are affected. A credit score is a numerical expression based on an analysis of the level of a person’s credit files that represents an individual’s creditworthiness. CIBIL TransUnion, Equifax, CRIF High Mark and Experian are bureaus that maintain credit reports.
Several factors can affect your credit score. Credit bureaus use many factors to evaluate your credit score as follows:
- Credit history
- Use of credit
- Number of accounts
- New lines of credit
- Length of credit history
Bureaus use their trademark algorithms to calculate an applicant’s credit score. Therefore, applying for a personal loan can have both positive and negative effects on your credit score, as discussed in this article.
How can a Personal Loan Impact My Credit Score in 2022
A personal loan can ruin your credit score in the following ways:
1. Request for multiple loans
Most applicants see a drop in their credit score after applying for a new loan to close an old loan. When you apply for many loans, the lender will do a hard credit check to determine your creditworthiness, including your payment history and other debts. This loan application can lower your credit score.
2. More credit inquiries
A frequent personal loan inquiry can lead to hard inquiries on your credit report. Too many inquiries on your credit report in a short period of time can affect your credit score.
3. Missed payments
When you take out a personal loan, it lowers your credit score if you miss payments. This is because the Credit Bureaus will analyze your payment history, which will negatively affect your credit score. In such situations where you have missed a payment for some personal reason, depending on your existing relationship with the lender, you can explain the reason for the late payments.
Also Read – How To Apply Aadhar Card Personal Loan
How can a personal loan have a positive impact on your credit score?
Always keep in mind the factors below for a better credit score while taking a personal loan:
1. Pay off your loans on time
Missed or late payments are bad for your credit score. So making loan repayments on time will increase your credit score.
2. Automated repayments
The auto loan repayment method works best for late EMI payers because when you make an auto payment, you are telling the lender to deduct a set EMI on a set date, which will automatically be deducted on a fixed date and boost your credit score.
It lowers the credit utilization ratio
A personal loan helps limit your credit utilization rate. If your only source of credit has been credit cards, then adding personal loans will diversify your credit mix, and a diverse credit mix will positively affect your credit score.
Monitor your credit report
To know what affects your loan and credit score, you should check your credit report regularly. You can request credit reports from credit bureaus without damaging your credit score.
Keep the old loans
Never close your old credit accounts for new loans. The longer an old loan with a good credit score is present on your credit report, the higher the chances of getting a personal loan in the near future.
When should you apply for a personal loan?
Now that you have a brief idea about the nature of a loan, its advantages and disadvantages, you should also know when it is appropriate to apply for a personal loan.
- You are facing a costly emergency – it could be a medical emergency or a family crisis. Taking a credit card loan turns out to be much higher in such scenarios, so the best option would be to apply for a personal loan.
- You are paying off high interest debt – personal loans are excellent for consolidating existing high interest debt including paying off multiple credit cards.
- You don’t want to risk your assets – unlike home loans, which are only available against your house as security, you can get unsecured personal loans. Although personal loans may charge a higher interest rate than fixed-rate home equity or similar loans, they are a safer option for those looking to improve their credit score by taking minimal risk.
While some take out personal loans to finance holidays and weddings, using your personal loan amount can only be justified by your personal finances.
Living on a tight budget requires a closer look at the repayment terms of personal loans. Because defaulting on payments will take a toll on your credit history and make it even more difficult for you to qualify for any form of credit in the future.