A personal loan can serve as a useful financial tool, helping you with an urgent purchase or other needs. Actually, you can kill two birds with one stone: receive the money you need and make your credit score better.
In this article, we’ll tell you about the positive and negative effects of a personal loan and give some pieces of advice on your credit score improvements.
The credit score is a substantial parameter of modern human finical life. It defines your ability to take a loan in the eyes of lending organizations. A bad credit score means that you can borrow only a limited amount of money with high-interest rates. The mechanism is simple: for the lending organization, a bad credit score is a sign that you are not a reliable borrower.
All the risks connected to this issue are covered with high-interest rates. In the cases of particularly bad credit history, the lender can ever reject your loan application. Of course, there are services where you can receive small sums up to 1500 personal loans online even with a bad score, but it’s a last-ditch method. We hope that you will be able to avoid a bad score in the first place.
Let’s discuss how you can affect your credit and what factors are considered in its calculation.
How Is The Credit Score Calculated?
A credit score is a number between 300 and 850. The lowest value means the lowest chances of getting a loan in good conditions. The higher is the number, the better. Generally speaking, a score of more than 670 is a good sign for lenders. There are five categories of the score:
- Below 580 — A bad score, indicating high risks for lenders;
- 580-669 — A fairly good score, giving you a few chances of lenders’ approval;
- 670-739 — good average value; you have good opportunities for the loan on decent terms;
- 740-799 — a very good score, making you a responsible and reliable borrower in lenders’ eyes;
- Above 800 — an exceptional score, opening the doors to the best possible conditions.
Also, don’t forget that the score is not the only factor taken into consideration. The lender can have some conditions regarding your income amount, the duration of your employment, and the state of your bank account.
Interesting fact: 67% of Americans had a good or a very good credit score.
The credit score is based on five main parameters, each of those has inherent weight in the final calculation:
- 35% goes for the history of your payments;
- 30% is the total amount of money you owe at the moment;
- 15% gives the total length of your borrowing;
- 10% is for your new loans;
- 10% is the diversity of opened credit cards and other credit lines.
Of course, the percentage can vary from year to year and from country to country, but the idea is clear. These calculation results are a number or score, giving you a place in the overall rating. As you can see, your payment history is the main factor in this calculation, so pay attention to the payments schedule.
How Can A Personal Loan Affect Credit Score?
When you browse online, putting multiple loan offers for comparison, your credit rating is unaffected. But it’s useful to know that sometimes the application itself can make the score lower.
It means the information of your application is included in calculations, even if you haven’t received the money. So, make sure you choose the optimal loan and don’t make multiple submissions. Each filled form will cost you 5 points on average.
At the first stage, when you request a personal loan, your rating affects the terms and conditions of your future loan. But right after approval, the situation becomes reversed. At this point, the existence of a loan slightly reduces your credit, but it’s only a temporal effect.
Establishing a budget that accounts for all your debt repayments, including your personal loan, can help you avoid missing the monthly payments.
After several punctual payments, the score begins to grow. Nothing is so harmful to your total rating as missed or late payments. We are not talking about several days delay, but if you are 30 days behind schedule, a lender passes this data to the credit bureaus, damaging your credit.
Several late payments in a raw can cost you up to 100 points of the score. The frequency is important: the fewer delinquent payments, the lighter the consequence for your overall rating.
You can assume that the closed-end loan will inevitably improve your score. Sounds weird, but it’s not necessarily the truth. Remember that 10% of the credit score is formed by a total mix of all your borrowings. That’s why the repaid loan takes away several points from the total number.
For the same reason, debt consolidation can be a bad idea if you’re planning to take a loan. Lenders prefer clients able to manage several sources of debt successfully.
At the same time, taking a loan for your debt consolidation is the best scenario. You will project a positive image to the lender and solve the problem with multiple payments, replacing them with one.
For What Period Does Taking A Loan Affect Credit Score
Each loan submission is taken into account for a year; they are completely erased in two years and don’t impact your history.
Late payment decreases your rating for the period of seven years.
Other parameters, such as your debt amount or history of timely payments, have more long-term and stable effects.
In other words, if you draw a line indicating your credit score changes over time, it will resemble a roller-coaster. The total score will vary, sometimes significantly. But when you pay on time, you’ll end the loan with a higher score.
That’s why the main recommendation regarding a personal loan is sticking to a payments schedule. Maybe you even have a student loan that is currently held by your parents and now is the time for it to be transferred into your name officially. Luckily, when refinancing a parent plus loan into your name you are able to re-evaluate interest rates, choose the lowest option that works for you and pay the loan off quicker. If you have trouble with self-discipline, use automatic payments offered by most banks. It can be a useful tool, allowing you to fulfill your obligations without too much struggle.
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