A personal loan does affect your credit score. Emergency expenses come unannounced! There are chances that we might run into an unforeseen emergency expense many times in our life. Although some are manageable, some expenses might hit you when you are already tight on your finances.
That’s when you think about applying for a personal loan. A personal loan can come in handy during such times. But there is a myth about them saying personal loans can hurt your credit score badly. But that isn’t completely true. We can take a deep dig into the subject in this article.
Table of Contents
- Key Takeaways
- Credit Scores & Personal loans
- What is a Credit Score?
- Credit Categories
- What Affects Your Credit Score
- Why do People Choose Personal Loans
- How Does Personal Loan Affect Your Credit Score?
- Stages at Which a Personal Loan can Affect Your Credit Score
- Applying for a Personal Loan
- Availing a Personal Loan
- Repayment of Personal Loan
- Stages at Which a Personal Loan can Affect Your Credit Score
1) Key Takeaways
- Personal loans may hurt or affect your credit score during the initial times
- A hard inquiry on credit scores may affect the score and can knock off a few points
- Personal loans and credit score affect each other in both good and bad ways.
- Once you have started paying off your personal loan on time, it proves your creditworthiness and in turn, helps in improving your credit score.
2) Credit Scores & Personal loans
You have come here to know if your personal loan will affect your credit score, but before going into that it’s important to know how the whole credit score system works.
2.1) What is a Credit Score?
A credit score is something that determines the creditworthiness of the customer. To make it easier for the lenders the credit information companies such as Experian, CIBIL and Equifax collects the credit information and consolidates them as scores. The credit score ranges from 300 to 850.
2.2) Credit Categories
Credit scores are categorised into 5 types based on the consumer’s creditworthiness and their ability to repay the loan. Poor, fair, good, very good, and exceptional are the 5 categories.
- Poor: If your credit score is below 580 you are considered as a risky borrower and you should work on building it.
- Fair: If your credit score is between 580 to 669, It’s considered not so good. But still, some lenders may offer you a loan but you can’t expect a good deal.
- Good: Credit scores between 670 to 739 are considered as good by the lenders.
- Very Good: If your credit score falls between 740 to 800 you will be seen as a dependable borrower by the lenders. You have high chances of getting a good deal.
- Exceptional: Credit scores above 800 points are viewed as exceptional scored by the lenders.
As we said already, before discussing how does a personal loan affect your credit score, you should know that you should have a good credit score to avail a personal loan.
2.3) What Affects Your Credit Score
There are five factors that can affect your credit score, the weightage of each factor may change with different agencies but these are the common factors that affect your credit score and their average weightage on your score.
- Payment History – Paying bills on time is an important factor with an average weightage of 35%. If you have never defaulted in paying your bills, there is nothing to worry about
- Utilizing the Credit – Your outstanding debt against your total credit limit is called credit utilization. It has an average weightage of about 30% on your credit score. If your credit limit is 30,000 and if you have used it completely, then it’s going to impact on your credit score
- Credit History Length- How long have you been borrowing and repaying properly has to do something with your credit score. This accounts for an average of 10% weightage in their credit score.
- Someone who has started their credit journey during their college times will have a better score compared to the one who has started it recently. To start building your credit score at an early age, you can utilize StuCred interest-free short loans for college students
- Credit Mix- Having a mix of credits is better than having just one type of credit. This weighs an average of 10% in one’s credit score.
- New Credit – Too many new credits at a short duration may hurt your credit score badly. This has an average weightage of 10% on your credit score. Too many new credits may give the impression that you are pushing yourselves too much and borrowing more than what you could pay
2.4) Why do People Choose Personal Loans
Personal loans can be used for various purposes. people may normally avail a personal loan to tackle an emergency expense or to visit your dream destination while you are short of money.
People also avail personal loans at a lesser rate to close their debts which is eating their money at a higher rate.
For example, you can avail a personal loan at 9% interest rate and close that high-interest credit card debt that was haunting you for months.
3) How Does Personal Loan Affect Your Credit Score?
Just like any other credits, a personal loan will also make an impact or does affect your credit score. It does good when you make payments on time and affects badly when you default or do late repayments.
3.1) Stages at Which a Personal Loan can Affect Your Credit Score.
Mentioned below are the stages of a personal loan cycle that affect your credit score.
3.1.1) Applying for a Personal Loan
Keep in mind that while you apply for a personal loan, the lender will do a hard inquiry on your credit score to check your creditworthiness. A hard inquiry will cause a small negative impact on your credit score.
3.1.2) Availing a Personal Loan
While you avail for a personal loan, there are many things that cause your credit score to fluctuate. If this personal loan of yours brings a good credit mix, it will make a positive impact.
But you should also make sure that you are not utilizing too much of your credit limit. It, not just affects your credit score but also brings a burden to you. If you are using your personal loan to pay off another high-interest loan it will do good for you.
3.1.3) Repayment of Personal Loan
This is a crucial step in the cycle. If you pay your dues on time it will help you improve your credit score greatly making the slight fluctuations during the other stages negligible. But if you fail to pay the debts on time your credit score will be impacted badly.
when personal loans are availed and are paid on time, they will help you in building your credit score easily. Personal loans are not meant to be availed to spend on something which you otherwise couldn’t afford. The best use of personal loans is to pay off loans with high-interest rates.
You should also keep in your mind that this huge outstanding debt will limit your borrowing ability by any other means for a longer duration.
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