While you may be living off well financially, with no constraints, if you ever want to borrow funds, then credit score is something you must focus to build. Maintaining a good credit score has several benefits besides making your fund-borrowing journey successful. A good credit score signifies you are responsible at credit utilization and can deal with EMIs on time.
So, how to build a credit score for better? The answer is, take a personal loan if you are in need of an unsecured loan for an immediate or planned expense. Now, let’s understand the fact – a personal loan can either help build a credit score or hurt it. It is how responsibly you use credit and keep a clean repayment record, which influences the impact of a personal loan on your credit score.
But, you may question – why take a personal loan when using a credit card can also increase your credit score? That makes sense, but instalment loans such as personal loans are accounted as more crucial in improving your credit score than a line of credit on revolving balances.
Credit Score – How does it Work?
Your credit report keeps a track of repayment history of at least the last 7 years, depending on which you are given a credit score. Some of the details which the report consists of are reported defaults, type of credit, the amount of credit, total open credit lines, payment history of Credit cards bills, credit accounts, liens against you, debt collection actions if any, recent hard credit inquiries, ongoing EMIs, bankruptcy, etc.
This information is then decoded by credit bureau agencies to mark a credit score to you. A credit report is prepared by Experian, TransUnion, and Equifax, and you can access your credit report from any of the mentioned credit bureaus. The higher your credit score, the easier it will be to attain a loan, and vice-versa. Your credit score is usually dominated by the total amounts owed, your payment history, credit history, credit mix, and recent credit inquiries.
Below-mentioned is how a personal loan influences your credit score:
- Personal Loan and the Owed Amounts
Like discussed above, the credit report will contain details of total amounts owed, so when you take a personal loan, it adds to this section. In the short-term, a new loan may lower your score, but if you have a thin credit history, then the loan can balance out the owed amounts, in the long run. Pay the dues in time to show that you can manage the debt load and are one of the potential borrowers, whom banks and NBFCs should consider as creditworthy.
- Impact of a Personal Loan on Your Payment History
If the payment schedule is such that you have to pay monthly EMIs, then you should not delay or miss the payments. One late payment can drastically affect your score. On the other hand, to build and maintain a good credit score, months and years of on-time payments is required. So, if you wish to repair your payment history, then regularly paying your personal loan instalment will help improve the credit score.
- Length of Payment History
Older credit accounts boost your credit score. So the longer you pay off the loan, the average age of credit accounts also increase. But when you finally repay the loan, it may cause a slight drop in the score. This is why they say not to close too many credit cards at once. So, make sure you maintain an average age for your open accounts, after all the age of these accounts and the higher overall credit limit on the card helps build the score.
- Credit Mix
Though the above-mentioned areas influence your credit score the most, credit mix also has some impact. Credit mix is the type of loans or credit cards you have taken out. But, is a personal loan is good for your credit mix or not, depends on the other kinds of loans in the bag. For instance, if you take a personal loan, but already have an ongoing auto loan, and maintaining a credit card, all of which that you utilize responsibly then your credit score may improve. But, you have two personal loans, and take the third one then your score may dip. Basically, it is best to have a diverse mix of borrowings, which increases the credit score if the repayment record is good.
- Debt Consolidation
Personal loan can be taken to consolidate debt. This can help boost your credit score as your credit utilization decreases, pulling different payments towards different loans under one single repayment with a personal loan. But it is only wise to choose debt consolidation with a loan if the interest rate of the new loan is lower than the overall cost of the consolidated loans.
- Avoid No Credit Check Personal Loans
There could be offers to personal loans without a credit check. Here, the loan amount is usually small at a high rate of interest. Your repayment capacity is based on your current EMIs and monthly income, apart from the employment status. But no hard credit inquiry is initiated. When you repay this loan, your repayment activity is not conveyed to the credit bureaus, but if you default on payments, the same gets reported to the agency, which can drop your credit score. You must stay away from taking such kind of loan, as it will not help in boosting your credit score.
- New Credit Inquiries
The financial institution will run a hard check on your credit when you drop a personal loan application. The bank will access the complete credit report so that it can analyze your credit history, and make a decision as to approve the application or not. However, too many credit inquiries at the same time result in pulling up the credit report over and again in a short-time, which negatively affects credit score. So, make sure to not apply with too many banks at a time, or it may hamper the credit score.
The above-mentioned guide explains how a personal impacts your credit score, for negative or positive. You must use any credit facility responsibly in order to maintain a good credit score. Make your payments on time and take a loan amount you can pay the EMI for comfortably without disrupting your current financial condition.