Your credit score significantly influences your financial future. It can affect your ability to get a mortgage, a car loan, or even a job. A low credit score can cause higher interest rates on loans and credit cards, sometimes leading to a denied loan application.
You can request a loan with digital lending institutions like GetCash that work with borrowers with varied credit histories. However, you may not get the rates and loan terms you want.
That’s why it’s crucial to understand how several actions, such as taking a personal loan, can impact your credit score. This article will discuss five ways personal loans can affect your credit score.
Table of Contents
The Importance of Having a Good Credit Score
A good credit score is essential for several reasons. For one, it can help you qualify for loans and lines of credit at favourable interest rates. A good credit score stipulates that you’re a low-risk borrower, which means they’re more likely to approve your loan application.
A good credit score can also help you save money on insurance premiums. Many insurance companies consider your credit score when setting rates, so a higher score could lead to lower premiums.
5 Ways Personal Loans Affect Your Credit Score
Payment History
Your payment history is the most significant factor in your credit score, accounting for 35% of your FICO score. When you have a personal loan and make timely payments, it can positively impact your credit score. On the other hand, if you’re delinquent on payments, it will negatively impact your credit score.
Total Amount of Debt
Your total debt, also known as your credit utilization ratio, is another critical factor in your credit score. It accounts for 30% of your FICO score. Your credit utilization ratio is the amount of debt you have divided by the amount of credit you have available. For example, if you have a $500 balance on a credit card with a $1,000 credit limit, your credit utilization ratio would be 50%.
Taking out a personal loan and using it to pay off high-interest debt, like credit card debt, can decrease your credit utilization ratio and improve your credit score. However, if you keep the same level of debt but have less available credit, your credit score will decrease from having an increased credit utilization ratio.
Length of Credit History
This factor accounts for 15% of your FICO score. Old credit cards and loans with a more extended repayment period can benefit your credit score because it shows that you can maintain an excellent longstanding relationship with your lenders. Since personal loans are usually paid in a few months, taking one out can shorten your length of credit history if you don’t have a long credit history, to begin with.
Credit Mix
This factor accounts for 10% of the total. Your credit mix refers to the variety of debt you have, such as auto loans, student loans, mortgages, and credit cards. Before requesting a personal loan, consider if it will make your credit mix less or more diverse.
If you have a lot of credit card debt and no other loans, taking out a personal loan improves your credit mix and, in turn, your credit score.
Credit Inquiries
When you submit your personal loan application, the lender will most likely check your credit history. A soft credit check won’t have any effect on your score, while a hard credit check will affect it. Credit inquiries contribute 10% of your total credit score.
Lenders perform a hard credit check by pulling a complete copy of your credit report, which appears on your report as an inquiry. If you have a lot of inquiries in a short period, it can signal to lenders that you badly need money and are more likely to default on a loan.
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Final Words
Personal loans affect your credit score in several positive and negative ways. It’s important to consider how a personal loan will impact your credit score before you apply for one.
A personal loan can positively influence your credit score by diversifying your credit mix and lowering your credit utilization ratio. However, it can also harm your score if you have a short credit history or a lot of inquiries in a short period.
If you want to take out a personal loan, it’s important to weigh the pros and cons. Personal loans can help consolidate debt and improve your credit score, but they’re not suitable for everyone.
