Some of the biggest expenses in your life may require external financial assistance. From home renovations to weddings or a big medical bill, you can find a handful of solutions in financial situations to cover these costs, such as a personal loan.
As one of the most popular forms of credit, a personal loan helps consumers in improving their financial health and paying urgent expenses. However, many people ask if personal loans have a negative effect on the credit score and should be avoided. In reality, the contrary is true. A personal loan can actually improve your credit score if used wisely.
Factors Affecting Credit Scores
To fully understand the interconnection between a personal loan and a credit score, it’s important to make sense of the factors influencing credit scores. Some of them are as follows:
- Delays in paying the dues of credit card
- Not paying the loan dues
- Filing for bankruptcy
- Frequently using a credit card over the maximum limit
- Closing a credit card with an outstanding balance amount
- Applying for various credit cards simultaneously
A bad credit score can eventually make it difficult to get loans, buy items like houses, and even get jobs in the financial sector because many employers run background checks on potential employees. This also means that lenders will look into the credit score history of the customer to identify if they’re suitable for personal loans.
Benefits of Getting a Personal Loan
A personal loan can help in making an urgent financial payment. It can even help in:
- Taking a vacation
- Renovating the home
- Funding higher education
- Paying for medical emergency
- Paying for weddings
- Buying household appliances or gadgets
- Funding businesses or professional practices
A lender may disburse a personal loan based on the individual’s credit score, income level, employment history, and repayment capacity. There are also a lot of benefits of getting a personal loan, such as:
- The paperwork is quite easy and simple and can even be completed online by lenders in some cases.
- You can avail of these loans for a variety of reasons, and the lender may not question the reasoning a lot.
- There is no requirement for collateral because a personal loan is considered to be an unsecured loan. Accordingly, it does not require the customer to pledge their assets.
- Personal loans also come with lower interest rates.
How Does a Personal Loan Influence the Credit Score?
A personal loan is known for its easy availability and variety of uses. It can help with unplanned financial emergencies. Plus, getting a personal loan is also not that difficult to get, with many financial institutions providing approval for these loans in a quick and efficient manner.
A good credit score is indeed required to be eligible to get a personal loan. However, it will be surprising to know that a personal loan can also help improve the credit score if used correctly.
Getting a personal loan has no profound influence on the credit score. In fact, it’s the way a personal loan is used that determines its effects on the overall credit score of the customer.
Ways to Improve the Credit Score Through A Personal Loan
There are a couple of ways to improve your credit score with the help of a personal loan. Some of these are highlighted below:
- Pay the dues on time: Timely repayment positively affects the credit score. It shows that the individual takes their finances seriously, and the financial institutes can trust you with finances.
- Build credit history: A long credit history shows responsibility with credit over time as well. It helps in improving the credit score but also the credit profile of the customer.
- Diversify the credit mix: For those who have a history of borrowing, it’s always a good idea to diversify the credit mix because leaning towards a specific type of loan can influence the credit score in the long run. Therefore, if borrowing is necessary, it’s a good idea to look into a variety of loans instead of just getting the same loan over and over again.
- Cut down load on credit card limits: It’s important to be aware of the maximum limits on the cards and not go over them because it can reflect very poorly on the overall credit score.
There are also other things to remember when getting a personal loan. For instance, applying for a personal loan right after applying for a credit card can actually negatively affect the credit score because it can lead to a hard inquiry. A recurrent debt cycle can also influence the credit score badly. For instance, if the person has taken a personal loan to pay for their credit card dues and right after paying their debts they max out the credit card once again, it can reflect negatively on the credit score history.
Therefore, one should be smart about getting a personal loan at the end of the day. Despite the easy documentation and application process, getting a personal loan should not be considered a way to get just about anything. Late repayment of the loan dues can have a very negative effect on the financial health and the credit history of a person. In the long run, a personal loan that was bought for debt consolidation can become an extra financial burden.
Conclusion
A personal loan is a cost-effective and time-efficient way of funding a very large expense or even consolidating debt. However, just like many other financial situations, personal loans can have varying effects on the credit score depending on how it’s being used. A good credit score goes a long way in improving the financial health of a person, and a personal loan can play a critical role in improving it.Â