We are sure all of us need some form of credit at some point in our lives, be it for buying a phone or for travelling to our favourite destination or to buy the latest gadget. Lenders have designed a plethora of loan offerings to cater to all the financial needs of customers. However, If you take a loan of any kind, your credit score is bound to be impacted to some degree. Let us understand in detail, the link between a personal loan and a credit score.
What is a Personal Loan?
A personal loan is an all-purpose consumer loan that can be availed to meet any financial requirements. Rates on personal loans are usually lower than on credit cards, thus making them a more preferred financial instrument.
Why would you take a Personal Loan?
People usually choose a personal loan to start a business, meet a sudden emergency expense or make an urgent big-ticket purchase or pay off another loan quickly. You would opt for a personal loan generally when the need is urgent. In the current scenario where due to the pandemic, life has become uncertain and medical bills are mounting, a personal loan could be a solution for those looking for financial relief.
Personal Loan Impact on credit score
Before you take a personal loan, you need to consider all the factors involved. One of the most important factors is to understand how it would impact your credit score. A good credit score is a non-negotiable requirement if you are willing to improve your access to credit. It is important to maintain a good credit score to have all lines of credit open. Taking a personal loan does have a direct impact on your credit score. To understand the Personal Loan impact on Credit Score, we need to first look at how the credit score is calculated.
Calculation of Credit Score
One of the main criteria for the calculation of credit score is whether you are repaying your debts on time or not. A credit score is calculated by using information from your credit reports and include
- Credit History
- Total debt involved
- Length of your credit history
- Credit Mix
- Latest credit enquiries
Credit History and total debt involved account for approximately 65% weightage while the other three factors make up the remaining 35%
How does a Personal Loan impact your credit score?
When credit is used responsibly, it has a favourable impact on the credit score. As already mentioned, it is your payment history that will determine whether the personal loan will have a positive or negative impact on your score. Timely repayments and the absence of defaults help to improve the credit score over a period of time.
Personal loans should not be used for frivolous spending beyond your means. They provide a very good line of credit in case of an emergency. Since personal loans are unsecured loans, they do not need any collateral, thus interest rates may seem higher than those for secured loans like auto loans or home loans. However, their rates are much lower than credit cards. Sometimes people opt for personal loans to pay off their high-interest debts.
Where can you get a Personal Loan from?
Personal loans can be obtained from a bank or a fintech company. The loan terms and conditions will depend on your credit score, the loan amount and your monthly income. If your credit score is good, you can get a personal loan at better interest rates. It is no secret that lenders access the credit score of borrowers before approving a loan application, i.e. before being decisive in extending a loan to a borrower. Young professionals are keen on maintaining a good credit score so that they have lines of credit open.
Who calculates the Credit Score?
Credit bureaus like CIBIl maintain the credit score of borrowers and credit card users in India. The score ranges from 300-900 and anything above 700 is considered good. You can check the website of these bureaus if you want to know your credit score. Using a personal loan helps in reducing the ratio of credit utilization as overuse of credit cards and other credit lines may lead to unfavourable credit utilisation ratios.
However, each time you apply for a new loan, the credit score falls slightly and starts getting adjusted based on your repayment. If you delay your repayment or default, the amount overdue keeps increasing or if you have frequently defaulted, the credit score gets negatively impacted.
Paying off multiple loans by taking one personal loan may have a few benefits. You need to make only one payment. You may be able to negotiate a better rate and you may actually be able to improve your credit score. Thus, we can safely say that credit score gets impacted by personal loans.
The LoanTap Advantage
For all your personal loan requirements, you can visit https://loantap.in/ and we will be happy to assist you. You can fill the loan application online, using the web or Mobile App. Once the KYC verification process is complete, you can have an instant fund transfer. The whole process takes only 24-36 hours. You can get Flexi personal loans with no prepayment charges, multiple withdrawals and free part payments.
Personal loans do have an impact on the Credit Score but if repayment is managed responsibly, it works towards improving your credit score as well as your credit history. Personal loans can be used as a short term financing option in case you need it for your business or to meet an emergency. Handling credit is a responsibility and should be undertaken only when you are confident about repayments.
Related article – How to use Personal loans to get better credit scores?