Does a Personal Loan Affect Your Credit Score?

Many people who plan to apply for a personal loan wonder – Does a Personal Loan Affect Credit score? Well, yes, it does! All kinds of loans impact credit reports. Whether the loan impacts you positively or negatively depends on your repayment!

While some think that taking a personal loan lowers your credit score, it can boost your credit score! Applying for a personal loan and making the payments on time can significantly improve your credit health and score.

To know how personal loan affect credit score, it is essential to understand what makes a credit score first.

Credit Score Working

The credit bureaus calculate the credit score of borrowers based on their credit behavior. They use proprietary algorithms to calculate the score. The credit score ranges between 300 and 850. If you have a credit score of 700 and above, the lenders will be ready to sanction your loan or other lines of credit. To check your credit score, visit these bureaus’ official websites or ask Ava Finance to provide a free credit report.

Certain important factors help in calculating credit scores. The critical factors include credit repayment, utilization, history, mix, and new credit applications.

Personal Loan and Credit Score

A personal loan is an unsecured loan, which means you don’t need to submit any collateral to procure the amount. As the loan is unsecured, the lenders charge a little higher interest rate to provide this type of loan. Despite this, people prefer choosing personal loans to manage critical financial needs.

However, personal loan does not affect your credit score in isolation. The personal loan’s impact on your credit depends on how you handle the loan. If you repay the personal loan on time and maintain an impeccable credit history, your credit score will only improve and not decrease.

Let us discuss the same in detail below.

The Impact of Personal Loans on Credit Scores

When you apply for a personal loan or any other type of credit, the lender requests access to your credit report. The lender wishes to know your credit health or credit history to assess whether you can loan repayment. When the lender generates such a request, called a ‘hard inquiry’, it can lead to a drop in the credit score. However, this drop is temporary. You can recover the same in a few months or a maximum of one year. The impact decreases over time when you show positive credit behavior.

Here is what makes a personal loan good for your credit score:

1. Timely Payments

When you make timely payments of the personal loan EMIs, you can improve your credit score. But when you miss or delay payments, your credit score is reduced. Your credit score can be lost if you miss a monthly payment. A missed payment impacts your credit much more than other factors. So, if you ensure regular personal loan payments, you will maintain and boost your credit score.

2. Low CUR

It is also important to note that using a personal loan for debt consolidation can increase your credit score, too. The personal loan will charge a lower interest rate than a higher-interest credit card debt. Reducing credit card balances also lowers your CUR (credit utilization ratio). A low credit utilization can substantially increase your credit score.

3. Increased Credit Mix

One of the factors that determine your credit score is credit mix. The lenders like the borrowers’ having multiple accounts and different kinds of debt. A new personal loan can increase the variety, enhance the credit mix, and improve your credit score.