Home Finance How Do Loans Affect Credit Score?

How Do Loans Affect Credit Score?

9 min read
Comments Off on How Do Loans Affect Credit Score?

Three UK reference agencies; Equifax, Experian and TransUnion are mandated to calculate your credit score. Loans and how you manage them are the most critical factors they consider in their calculations. Loans affect your credit score in several ways-both good and bad. Therefore, it is crucial for loan management as this either helps for a better credit score.

Loans, both new and existing, affect your credit in the following number of ways.

1.  Building Your Credit Rating

Your credit history determines your credit score as a borrower. Good past repayment records are a plus for you as lenders will assume that you will do the same with the new loans they advance. The longer you have serviced your loans well, the better for you.

You build your credit rating more by taking up new loans now and repay as agreed with your lender. In addition, you should strive to build your credit score by making agreed payments on time. How reliable you pay off your debts significantly contributes to your credit score.

2.  Late Loan Payments and Defaults

When you take up a loan and service it well, then your credit score improves. But, unfortunately, the same will suffer if you make late payments or defaults. It makes it harder for you to get new loans in the future.

It is advisable to talk to your lender early enough when your financial ability to service a loan reduces. They will provide several options for you, such as reducing your interest, refinance your loan, or consolidating your loans to come up with a lower monthly payment. This way, your credit ranking will not be in danger.

Do not borrow to improve your credit. You might end up borrowing money that you will eventually be unable to pay back. In addition, it will damage your credit score. Instead, borrow if and when you need to.

3.  New Loans and Your Ability to Borrow

Apart from affecting your credit scores, new loans also reduce your ability to borrow. Your credit report entails all the loans that you have and their monthly payments. Lenders look at your existing loans and decide whether they think you can afford to service a new loan. However, it does not directly affect your credit score.

They calculate the debt-to-income ratio, which tells the lenders how much of your income you spend on loan repayments. A lower ratio means that you are most likely going to qualify for a loan.

4.  How Cosigned Loans Impact Your Credit

Your ability to borrow is affected by loans that you are a guarantor to. They, therefore, appear on your credit report. In addition, you are responsible for repaying the loan in case the borrower fails to pay.

Even though you are not making any payments, lenders consider it as a monthly expense. Therefore, if the primary borrower defaults on payments, your credit score and ability to take new loans are greatly affected.

5.  The Credit Dip From New Loans

New loans affect your credit score through a hard inquiry from the lenders. Lenders check on your credit report every time you apply for a loan. The number of times lenders pull your account gives the lenders a financial perception of who you are as a borrower.

Lenders treat numerous inquiries into your credit account as somebody in financial problems and might lead to your loan denied and credit score reviewed downwards.

You can beat the credit dip by doing your loan shopping within a relatively short period. Additionally, the dip will be less significant with a strong credit score than one with a poor one that might lead to the dip lasting longer until you start making enough payments to improve your rating.

Also, take significant loans first to avoid the negative impacts of such a dip.

6.  Debt Consolidation

When you consolidate your debts by taking a personal loan, you can negotiate for lower interest rates, increasing your ability to pay the loan faster, hence improving your credit score.

7.  Your Credit Utilization

Credit utilization is how much of your available credit that you end up using. It accounts for a significant percentage in calculating your credit score. If you usually maximize the use of your credit cards, then your credit utilization is likely to be high, damaging your credit score. Always lower the ratio for good credit ratings.

8.  Improving Your Credit Mix

Your credit mix is also a determinant when calculating your credit score. Lenders like to see that you can handle different types of loans, such as credit cards, personal loans, auto loans, etc.

Try and diversify your credit mix to improve your credit ratings. For example, the next time you go for a loan, take a different type of loan that you have never taken before and make timely payments. It will significantly increase your credit ratings.

Credit scores are always a measure of your credit health. Proper loan management is critical for good credit health; borrow responsibly and make your payments on time. This way, you will be sure of a good credit score. It will be regrettable if you are denied a loan because of a bad credit report.  Improve on any factors that affect your creditworthiness, as you might not know when you will need that loan.

Load More Related Articles
Load More By Gabriel Hadden
Load More In Finance
Comments are closed.

Check Also

Do’s and Don’ts of Maintaining a Demat Account

Now that you havе your Dеmat account up and running,  it’s еssеntial to еnsurе you m…