Personal Loan and Its Impact on Your Credit Score

Your credit score works like a merit score for your loan applications and helps you get funds from banks and lenders when needed. A good credit score indicates the ability of an individual to repay borrowed money on time without any delays. Loan applications and repayment of loans play an important role in creating a good credit score. The question is, what’s the relationship between personal loans and credit score? Let’s find out. 

Understanding Personal Loan and Credit Score

As the name indicates, a personal loan doesn’t have to be taken for any specific reason, like an education loan. You can borrow this money from lenders and pay back EMIs at a rate of interest over a flexible period. Meanwhile, your credit score is a parameter for assessing your credit history and repayment behavior. 

The credit score ranges from 300 to 900; as your score inches towards 900, it gets better, and you become more credible to lenders. 

It is important to maintain a good credit score, especially for those who wish to get loans at affordable interest rates. 

In fact, that’s one of the key considerations for lenders who want to evaluate a borrower’s profile and the associated risk.

Here’s what your CIBIL score says:

• 300-499  Poor 
• 500-649  Average 
• 650-749  Good 
• 750-900  Excellent

You can easily check your credit score on trusted sites like Stashfin, where a few easy steps generate your score. The site also gives you detailed reports of your credit behavior and practical tips to improve your score. 

Is a Personal Loan a Good Choice?

If you are looking for sources of credit, then considering a personal loan is fair for its benefits and ease of application. Let’s check out the reasons why personal loan makes sense for borrowers:

Low credit score: Your credit score drops significantly when you miss your payment deadlines on credit. A low credit score immensely affects your loan applications, resulting in rejection of your future loans. If your credit score is low, personal loans can be your savior to get the required credit without the burden of getting rejected due to a bad credit score. 

Repayment Flexibility: These loans feature flexible repayment policies to maintain You have the ease of repaying the amount according to your capability. 

This removes the mental stress of repayment and the burden of EMIs to avoid bad credit scores. This repayment method helps families in times of distress and gives them the freedom to pay back their credit following a flexible repayment schedule.

Collateral not required: If your child is applying for an education loan beyond 7 Lakhs, central banks and other financial institutions state the need for collateral in your residing state. Personal loans can come to your rescue in such situations. 

This is because personal loans require no collateral. You can borrow money safely while achieving your financial objectives. 

Instant Access: Documentation for personal loans is quite easy and quick. It saves you multiple trips to the lender, as you can apply for it online and have your application processed within minutes. In many cases, money is credited on the same day your application is processed, which can help you during emergencies. 

Pay off debt: Credit card debts entail high interest rates, going up to 20%. Personal loans can be used to pay off credit card loans offered at high interest rates, which can help you save money. A personal loan is a practical solution if your credit card debt is getting costly.

Does Personal Loan Lower Your Credit Score?

Before understanding the impact of personal loans on credit score, it is important to understand the factors that contribute to your credit score: 

• Your credit history: Your repayment history affects your credit score the most. Missing EMIs or non-payment of debt leads to a drastic decrease in your credit score; thus, paying back your loan in a timely fashion is crucial.
• Credit mix: Having a versatile mix of credit helps you with easy repayment. 
• New credit inquiry: Your credit inquiries are also included in your credit report and slightly affect your credit score; however, they do not have a long-lasting impact like your credit history. 
• Credit utilization: It is the ratio of available debt to the debt being used by the individual. A lower credit utilization ratio reflects responsible behavior from the user and builds a good credit score. 

There are many misconceptions surrounding personal loans. The most prominent one is that taking a personal loan will negatively impact your credit score. 

Let’s debunk these myths:

• Myth: My credit score will decrease if I take a personal loan.

Fact: Your credit score is not rigorous; it keeps on changing, which means that when you miss your EMIs, it can drop drastically, but when you start paying your debt responsibly, it starts increasing steadily. In such situations, personal loans can help you in building a good credit score with timely payments.

• Myth: Personal loans have high interest rates.

Fact: Personal loans are also criticized for their high interest rates. Personal loans provide you with customizable amounts and interest rates as per your credit score. High interest rates do not impact your credit score directly; if you are paying back your credit timely, then you will maintain a good credit score irrespective of the rate of interest levied on the loan by the lender.

• Myth: New credit applications make my credit score drop.

Fact: Credit score depends on your new applications for loans. However, it doesn’t affect your score drastically. So, applying for a personal loan and paying it back as per directions will only help you positively grow your credit score and accountability amongst lenders.

Conclusion 

Personal loans can be helpful when managed efficiently and responsibly. Your credit score can be positively impacted by a personal loan if you utilise your repayment capacity and develop a healthy borrowing mechanism. A good credit score will eventually help you in getting lower interest rates for loans. 

Seek professional guidance from trusted lenders to understand the factors behind your credit score and choose the best way to borrow money as per your earning and spending habits to avoid any decrement in your credit score.