Do Personal Loans Affect Your Credit Score

Lenders now lay major emphasis on the credit score of the borrowers before approving a loan application. As a result, a large number of people, especially young working professionals, now look for ways to improve their creditworthiness. While there are ways to improve the credit score, there are also many myths surrounding the whole topic.

For instance, many believe that taking a personal loan would negatively affect their credit score. This is untrue, and as a matter of fact, a personal loan can be used for improving the credit score. To understand the relationship between a personal loan and credit score, it is first essential to know how the credit score is calculated.

Working of Credit Score

Credit bureaus like CIBIL are responsible for maintaining the credit score of borrowers and credit card users in India. The score ranges between 300 and 900 and anything above 750 is generally preferred by the banks. You can do a credit score check by visiting the official website of these bureaus.

Credit bureaus use many important factors to calculate someone's credit score. Some of the most critical factors in their decreasing order of importance are-

1. Credit history
2. Credit utilisation
3. Credit history length
4. Credit mix
5. New credit

The bureaus use their proprietary algorithms for calculating the credit score of individuals based on these factors.

Personal Loan and Credit Score

A personal loan is an unsecured type of loan which does not require you to submit any collateral against the loan amount. Personal loan interest rates are highly competitive nowadays, and this makes them an excellent choice for managing a host of your financial needs.

However, the type of loan doesn't make much difference for the credit bureaus. As long as you will repay the personal loan on time, the credit history, which is the most critical factor as mentioned above, will only improve.

Impact of Personal Loan on Other Credit Score Factors

Using a personal loan is considered to be a better option than using your credit cards as far as the credit rating is concerned. This is because taking personal loans online or offline helps in reducing the ratio of credit utilisation which is the second most important factor for credit bureaus.

The other factors such as credit history length and credit mix are also positively affected through personal loans in most cases. In short, taking a personal loan can actually help you improve 90% of the factors used by credit bureaus for calculating your credit score.

New Credit and Personal Loan Application

New credit is the last most important factor for the credit bureaus. Every time you apply for a new loan, your credit score falls slightly. This is the reason why it is said that you should avoid applying for loans at multiple lenders within a short duration.

However, this fall is very small and only temporary and will not really affect your credit score or personal loan eligibility in the long run. Once you start repaying the personal loan on time, this fall in the score gets eliminated, and you actually get the opportunity to improve the score.

The Bottomline

If you are looking for financial assistance, go ahead and apply for a personal loan and rest assured as long as you are borrowing responsibly and will repay the loan on time, the personal loan will only help your credit report.

Rather than believing such myths, it is better to consult with a top bank to make the right decision.

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