You’ve crashed your car, you’re looking to start a new business, you have unexpected medical bills…
There are so many reasons people take out personal loans, which can help pay for unexpected expenses when you don’t have cash on hand. It’s no secret that these personal loans affect your credit score – just like any other form of credit. They can improve your credit score, reduce your credit card debt and help you cover expenses, but they also come with costs and risks that need to be considered.
What Is A Personal Loan?
There are a number of different loans that can be taken out for different reasons. You can take out a mortgage to pay for a home, you can take out an auto loan for a new car, and you can take out a personal loan for almost anything you want.
The interest rates on personal loans are higher than your mortgage or auto loan, for the simple fact that you don’t have to put up any collateral, which means they are unsecured. However, they have lower interest rates than credit cards, which is why many people choose to take one out rather than paying for expenses on credit cards.
What Is A Credit Score?
Your credit score is a number, which determines how financially trustworthy a person is. The higher your score, the better your credit rating. This score determines how much a lender will let you borrow, along with the interest rate and other terms. This number is used to work out if you are worth the risk.
You can check your credit score here.
How Do Personal Loans Affect Credit Score?
Depending on how you tackle your personal loan, it can have a positive or negative impact on your credit rating.
How a personal loan can help your credit rating:
Timely loan repayments: If you make your loan repayments in a timely manner and meet all the conditions of the loan, this can actually have a positive impact on your credit rating. Even one single missed payment can hurt your score. By paying back what you need to on time, a future lender will be able to see this information reflected in your credit rating, increasing your likelihood of being able to take out another loan.
Better credit mix: a variety of different types of credit can help to boost your credit rating. For example, if you currently have credit cards contributing to most of your credit, adding in a personal loan enhances this mix.
How a personal loan can damage your credit rating:
Creating an inquiry: applying for any type of loan results in a credit check on you, which means you get a ‘hard inquiry’ noted on your credit report. This hard inquiry has a negative impact on your credit rating. Thankfully, this only lasts for a couple of months, unless you have too many of them. Don’t let this stop you from shopping around for the best deal. Carry out all your applications within a fortnight and consolidate them, as this will minimise their negative impact.
Not making payments: if you take out a personal loan and don’t meet the payment schedule or the terms of the agreement, this will have a negative effect on your credit rating. If you look to take out further loans in the future, the lender will be able to see how you handled your personal loan and this will factor into whether you are worth the risk. Someone who missed payments, underpaid, or had to be chased up, wouldn’t be considered worth the risk.
High loan balance: the balance left on your loan to pay off can also affect your credit rating. You will score points as you pay it off and this will slowly increase your credit rating. This is done for the simple reason of not allowing you to go into too much debt without it being noted through your credit rating.
Should You Take Out A Personal Loan?
Knowing the pros and cons of taking out a personal loan and how it affects your credit history will make it easier for you to decide whether this is right for you. There are so many different reasons for taking out a loan, and often the difference is between luxury expenses (wedding, an overseas holiday, etc) and necessary expenses (medical bills, house leak, etc). By weighing up the advantages and disadvantages you will be able to make the best choice for each circumstance.