A personal loan obtained online is particularly well-liked due to its many applications and accessibility. Because it doesn’t require any collateral or security and the approval process is considerably quicker than with other loans, it’s a great option to cover unforeseen financial demands or crises. Due to its versatility, this product is offered by the majority of lenders. Although it’s common knowledge that a Personal Loan may only be obtained with good credit, the inverse is also true. A personal loan might help you raise your credit score if used responsibly. Before delving into how a personal loan impacts your credit score, let’s briefly understand what credit score is.
What is a Credit Score?
A borrower’s credit score is a number based on the credit history that is given to them. The rating that defines how creditworthy they are is a number between 300 and 900. The better this number is, and vice versa, the closer it is to 900. The TransUnion CIBIL credit bureau in India uses a number of variables to determine a person’s credit score, including but not restricted to that person’s credit history, past payments, open credit accounts, credit utilisation ratio, and other criteria. The CIBIL score levels and their descriptions are as follows:
- More than 750 – Excellent: Represents prudent credit behaviour. Lenders favour these clients and provide them with the best interest rates as they are less prone to default.
- 650 – 749 – Good: There haven’t been many past missed or late payments. A lender will almost approve the loan, but at a higher interest rate and perhaps even with more paperwork.
- 550 – 649 – Average: Lenders could be reluctant to work with consumers who have credit scores between 550 and 649 because they have a history of risky financial behaviour. This group of people needs to raise their credit scores and can climb the credit ladder if they continue to practise sound money management.
- Less than 550 – Poor: People in this category are more likely to have previously missed payments or to have unpaid debts. Since this is a high-risk group for lenders, their chances of getting a loan are extremely limited.
Ways how a personal loan impacts your credit score
Defaulted Payments
Remember that skipping payments could cause your credit score to decline if you intend to borrow money. This is so that the bureau can assess your ability to meet deadlines and pay back obligations. Call your lender and explain why you’re having difficulties making payments before things get so bad that no one will give you money. Defaulting on a loan can seriously harm your credit report. On the other hand, if they know and trust you, they might occasionally cooperate with you.
Numerous Credit Inquiries
Repetitive enquiries may impact your credit score for personal loans. Therefore, watch out for too many personal loan queries on your credit report, especially if they happen quickly.
Submitting Multiple Loan Applications
After applying for a new personal loan to pay off the old one, many consumers have noticed a drop in their credit scores. When a borrower applies for many loans without first closing any of them, lenders do a hard credit check on them.
Ways to improve your credit score
Consolidating debts
You can combine numerous loans with various interest rates into a single Personal Loan if you manage both simultaneously. If the loan has an interest rate lower than the average of your current interest rates, your monthly interest expense will be decreased. The easier repayment due to the lower interest burden also raises your credit score over time.
Timely Repayment
On-time debt repayment is an indicator of good credit behaviour. This indicates sound money management, which raises Personal Loan credit scores. A Personal Unsecured Loan with no Late Payments significantly raises a person’s credit score.
Lowering Your Credit Utilisation Ratio
The amount of available credit you have used may account for up to 30% of your credit score. For example, if you frequently use all available credit on your cards, your credit usage is probably pretty high and will hurt your credit. However, you can raise your score by obtaining a personal loan for debt consolidation.
As instalment loans, personal loans are not included in the credit usage ratio. However, it is a wise move to lower your ratio and improve your credit by obtaining a low-interest personal loan to pay off your high-interest credit card debt.
