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Business News/ Money / Personal Finance/  Personal loans affect your credit score and here's what you need to know

Personal loans affect your credit score and here's what you need to know

The management of personal loans has the potential to influence your credit score, either positively or negatively, depending on your handling of the loan.

A personal loan can improve or damage your credit score depending on how you use it.Premium
A personal loan can improve or damage your credit score depending on how you use it.

While the general understanding is that a good credit score is necessary to secure a personal loan, the reverse is equally true. If utilised judiciously, a personal loan has the potential to enhance your credit score.

By responsibly utilising a personal loan and ensuring regular on-time payments, you make a positive contribution to your credit history. This showcases your adeptness in managing credit effectively and can result in:

  • Elevated credit score: Consistently making punctual payments on your loan can gradually enhance your credit score.
  • Enhanced access to future credit: A responsibly managed personal loan leading to a favourable credit score can open doors to other loan options in the future, potentially offering more favourable terms and interest rates.

Personal loans have the potential to adversely impact your credit score as well.

  • Too many inquiries about personal loans: When applying for a personal loan, lenders perform a hard inquiry on your credit report to evaluate your creditworthiness. While one or two inquiries may not have a substantial impact on your credit score, an excessive number of inquiries can negatively affect it.
  • Adding to the existing pile of debt: A personal loan is intended for consolidating existing debt, replacing higher-cost debt with a lower-cost alternative. If you are currently struggling to repay a significant amount of debt, using a personal loan for this purpose is considered responsible financial behavior and can potentially improve your credit score.

The positive influence on your credit score depends on the responsible use of the personal loan. Failing to make payments or defaulting on the loan can significantly harm your credit score, leading to the opposite outcome. Establishing a good credit score requires consistent effort and time. Although a personal loan can contribute positively, it is not a quick solution for a poor credit history.

Frequently Asked Questions (FAQs)

Q. Why is a good credit score needed to take a personal loan?

When you seek a personal loan, lenders evaluate your credit score to gauge your creditworthiness. A favourable credit score, usually surpassing 670, reflects a track record of prudent borrowing and punctual repayments, portraying you as a less risky borrower from their perspective. This results in:

  • Increased likelihood of approval: A good credit score enhances the chances of your loan application being approved.
  • Advantageous interest rates: Lenders provide lower interest rates to borrowers with good credit scores, resulting in reduced borrowing costs and increased affordability of the loan.

Q. Why should you apply for a personal loan from the right lender?

It's crucial to thoroughly research and choose the right lender before opting for a personal loan. Selecting a loan with high interest rates, processing fees, and charges can add to your financial burden. In such a scenario, any missed or delayed payments can have a detrimental impact on your credit score.

Q. How should you ensure that your personal loan does not affect your credit score?

The impact of a personal loan on your credit score hinges on your usage. Regardless of the loan type chosen, the key is to maintain sound financial habits. The following tips can assist you in building a robust credit score and experiencing stress-free financial management.

  • Only borrow an amount that you can comfortably repay without causing undue stress to your finances.
  • Adhere to your equated monthly installments (EMIs) with the utmost discipline, ensuring that payments are neither missed nor delayed.
  • Borrow only when there's a genuine need, and have a clear purpose for the borrowed amount before seeking a loan.
  • Determine the precise amount you need before applying for a loan, and borrow only what is necessary.
  • Conduct thorough research on lenders and their offerings, selecting a combination that aligns best with your needs.

Q. What is the personal loan credit score range?

Although there isn't a universally set minimum CIBIL score requirement for personal loans, lenders consider it a crucial factor in evaluating your creditworthiness and eligibility for a loan. The following provides an overview of the CIBIL score range and its general influence on personal loan applications:

  • 750 and above: Generally considered an excellent CIBIL score for personal loans. With a score in this range, there's a high likelihood of loan approval, and you may qualify for favourable interest rates and terms.
  • 600 to 749: Falls under the category of “fair" credit. While loan approval is still possible, interest rates may be higher compared to applicants with a higher score.
  • Below 600: A score below 600 is deemed “poor" or “low". Obtaining approval for a personal loan with this score can be challenging, and if approved, you might face significantly high interest rates and stricter loan terms.

Q. How do you enhance your credit score for a personal loan?

Boosting your credit score is crucial for increasing your likelihood of loan approval and securing more favourable terms for a personal loan. While it demands time and discipline, the rewards are significant. Here are some practical tips to elevate your credit score:

  • Make payments on time
  • Decrease credit utilisation
  • Restrict credit inquiries
  • Regularly check your credit report
  • Effectively handle current debts
  • Diversify your credit portfolio





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Published: 07 Mar 2024, 07:32 PM IST
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