There can be many reasons why someone takes out a personal loan, but one thing you should be aware of before you sign the agreement is how it affects your credit score.
We will walk you through the different ways, both negative and positive, that having and using a personal loan can affect your credit score.
What Is A Personal Loan?
Before we get started, we need to make sure you know which type of loan we are talking about. Personal loans are not the same as mortgages. Those types of loans are taken out for specific purposes, and you cannot use the money for any other reason.
Personal loans can be used for any reason or multiple reasons. Despite the name, you can take out a personal loan to start a business.
The most common use for a personal loan is to pay off a more expensive credit card. Personal loans tend to have a lower interest rate, so putting all your debts into one cheaper area can be easier to manage.
How Applying For A Personal Loan Affects Your Credit Score
The questions you’re asking shouldn’t be whether or not applying for a loan hurts your credit. Instead, you should be wondering when it hurts it and when it helps it, for a personal loan often does both.
When you apply for a loan, you want to be accepted. This isn’t just because you need the money asked for, but if you are rejected, this will show up on your credit report. The report will tell other lenders that someone found a fault in your application. It, therefore, warns other banks to be wary of you.
To some lenders, this is enough to deny you their patronage without further investigation.
However, if you do manage to get a loan, your credit score will also reduce. This is for a different reason, though, and after a couple of months of repaying, your status should go back to how it was. This is because the lender is showing everyone that you have taken out an agreement and haven’t proven your ability to repay yet. This is common practice, and once you have proven your ability to repay, the score should rise again.
How Do Payments And Fees On a Personal Loan Affect Your Credit Score?
Once you start making payments, your credit score will reflect how much you are able to repay and if you can do it in the agreed time frame. If you have opened a personal loan that is larger than any other in the last 7 years and show you can pay it back successfully, your credit score will not only go back to its original state, it will also increase.
This is because you are showing other lenders that you can take on more responsibility, communicate with your agreement, and can do so without hassle. These are all qualities lenders want to see.
If you fail to pay on time and receive a late payment fee, this will lower your credit score. It will also show a default on your credit, which will stay on your file for 7 years. This is to inform other lenders that you could not make your payments.
Because of this, you need to take late payments seriously and be aware of the commitment you have agreed to.
Does Having Multiple Lines Of Credit Hurt Your Credit Score?
This question is a little complicated. Having a lot of loans or even loans of the same size will tell other lenders that you are slowly losing control of your financial situation. However, if you continue to make repayments on time, they will see you are a good investment for interest payments.
This means your credit score might be “good” instead of “excellent.” This isn’t a problem, as a good score can still lead to buying phone contracts and credit cards.
On the other hand, if you have lots of different types of credit, all of which you are proving to pay effectively, the lenders will see you are a diverse platform, and you will be praised with a high credit score. This could be something as simple as having a phone contract, a credit card, a mortgage, and a personal loan. This mixture of credit shows the lenders that you can handle different situations easily and are using their services to achieve appropriate goals.
What Does A Credit Report Consist Of?
The majority of your credit report will consist of your payment history. This is the most important thing for you to be aware of, and it is something you can affect every month.
To easily boost your credit score, you should make early payments of the exact amount needed or slightly more.
The second most important factor is how much you currently owe. The best credit scores have a low amount of debt, but not none. Credit is needed to prove you can borrow effectively, so having no debts whatsoever means the credit report has no way to monitor you.
The next important factor is the length of your credit history. If you have no credit history, then you will not have a good credit score, but if you have a 40-year mortgage, then you’ll have a long line of credit that can be used for data.
The last two factors have the same amount of weight applied to them. The first is the mixture of credit you have, like phone contracts, mortgages, and personal loans. The second is how new the credit is. New credit information gives lenders a realistic understanding of how you are coping financially in recent history.
In total, the percentages are:
- 35% Payment History
- 30% Amount Of Debt
- 15% Length Of Credit history
- 10% Types Of Credit
- 10% Recent Credit History