Here’s how personal loan affects your credit score

Personal Loan

Personal loans are the best way to finance your extra needs, which generally becomes difficult to manage from the regular income. The demand for Personal loan is increasing day by day, due to its easy availability and to live up to the increasing cost of living. Personal loans are unsecured and don’t require any security to be put up as collateral. It possesses the power to build your credit score, along with making the cash available easily, to meet your urgent financial requirements. 

When you are planning to avail a personal loan, it is pivotal to bear in mind to repay it responsibly. You should always avail of the loan amount, which will fulfill your requirement, then what you are eligible for. This will save you from the extra burden of repaying the loan, in addition to the applicable interest rates. Because for any reason, if you miss the repayment of installment, your credit score will be badly hampered. A credit score is an indicator of how well you manage your finances and determines your creditworthiness for your future borrowings. If you are dealing with a bad credit score, availing HDFC Bank Personal Loan and its timely repayments can boost your credit score within months. 

FICO or Fair Isaac Corporation were the first ones to create the model for a credit score, which is used by financial institutions. A credit score is a statistical number that evaluates an applicant’s creditworthiness. An applicant’s credit score ranges from 300-900, and the higher the credit score, the more financially trustworthy a person is considered to be. Based on the numbers of the applicant, the lender evaluates, whether or not the individual will repay his or her debts.

Generally, a credit score of an individual is built within a period of 18-36 months or more, from the information obtained from various sources. Those sources are banks, credit card companies, collection agencies, and governments. RBI has licensed few Credit Information companies to operate, and among them, CIBIL or The Credit Information Bureau is the most popular. The reports of the credit information companies comprise, the age of one’s credit accounts, the type of credit in your possession, how much credit you have utilized to date, total open lines of credit, debt collection actions  taken against one, as well as recent inquiries for hard credit. 

Let’s find out how Personal loan affects your credit score. 

Repayment of loan installments on time 

Maintain a credit discipline when it comes to repayment of loan EMIs. The auto-debit system used by the banks ensures you need not remember to transfer the EMI to the bank, every month. If all the installments are paid on time to the bank, your credit score will rise significantly within a short span on time. This is eventually put your name in the most preferred borrower’s list. In the long run, if you want to apply for any other loans, it will turn out to benefit you. It will create a positive impact in the eyes of the lender and will make you trustworthy for future borrowings.

Debt to income ratio and loan

The income you receive every month determines, whether you are capable of repaying the loan amount or not. It is the measure which is taken into consideration by banks, how much you will be able to spend on repayments of the debt amount. Few lenders have come up with their debt to income ratio, to be used in the form of credit consideration. These measures will damage the credit consideration and will not let you apply for loans. It is important not to consider such financial institutions when applying for a personal loan.

Late payment fee 

Few lenders charge you an origination fee, which is unavoidable. It is taken off from the loan amount payment. This fee depends on the amount of loan you are planning to borrow. Late payments can lead to the late expenses and overdraft of fees. Hence it is crucial to pay the EMIs before the deadline.

A mix of all credit types

Five factors are responsible for determining your credit score. They are – your payment history, utilization of the credit, length of credit history, the credit mix and new inquiries of the credit in accordance with FICO. When you apply for a Personal loan, the mix of all credit types will be viewed at a high level of approval by lenders and creditors.

Avoiding penalties in payments

When a financial institution lends you the loan, they are looking to get an expected return out of it. If you tend to return the loan earlier than the fixed date, they loose on the amount they could have made. Because of this, they charge you an additional fee for the early payment which you have done. 

The Solution

  • Pay all your dues on time. Set reminders and follow credit discipline. Missing out on payments can deteriorate your score to a large extent.
  • Avoid piling up too much debt at a time. It will crash your score and might put you on the radar of the unending cycle of debts, further decreasing your CIBIL score.
  • Have the right combination of credit mix. Too many unsecured loans at a time are viewed negatively. Keeping a mix of secured loans and unsecured loans tends to build a positive credit score.
  • Avoid applying for new credit unless it is very important. A lot of debt at the same time creates an impression that you are always in the need for credit.
  • It is wise to become a guarantor to someone worthy of trust. If your co-signee neglects the payments with the banks, it will have a bad effect on your credit score. 
  • Keep monitoring your CIBIL score regularly and report it if you find any mismatch on the same. If the reports are not updated, it can create a negative impact on your credit profile.
  • Try to keep the tenure of your loan longer, and ensure the EMI is low. You can also increase your credit limit, keeping the utilization to low, creating a positive impact on your CIBIL score.

With the changing times, the needs of day to day life are ever increasing and to meet the requirement, Personal loans is the optimum choice for most borrowers. But it is also equally important to keep the above factors in mind before availing the Personal Loan, to avoid posing a negative impact on your credit profile.

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