In today's fast-paced world, personal loans have become a popular financial tool for individuals looking to meet various financial needs. Whether it is consolidating debt, funding a dream vacation, or covering unexpected expenses, a personal loan can offer a convenient solution. However, understanding how a personal loan can impact your credit score is essential before you dive into the borrowing process. In this article, we will explore the relationship between personal loans and credit scores, shedding light on the factors that can influence your creditworthiness.
Personal loan and credit score explained
Before delving into the effects, let us briefly understand the two key components involved: personal loans and credit scores. A personal loan is an unsecured loan that allows you to borrow a specific amount from a financial institution or lender. Unlike secured loans (for example, home loans or car loans), personal loans generally do not require collateral, making them accessible to a wider range of individuals.
On the other hand, a credit score refers to a three-digit number that indicates an individual's creditworthiness and financial history. In India, the most commonly used credit scoring system is the CIBIL Score, which ranges from 300 to 900. A higher credit score signifies a lower credit risk, making it easier to secure loans at favourable terms.
1. Impact on payment history
Timely payment of personal loan EMIs is crucial for maintaining a positive credit score. Missing or making late payments can significantly damage your credit history. Lenders report loan repayments to credit bureaus like TransUnion CIBIL, which affects your credit score. Consistently paying your EMIs on time will have a positive impact on your credit score.
2. Influence on credit utilisation ratio
The credit utilisation ratio is the percentage of your total available credit that you are using. A personal loan can affect this ratio positively or negatively, depending on how you manage the loan amount. When you take a personal loan, your available credit decreases, but if you pay off credit card debt with the loan, your credit utilisation ratio improves, leading to a potential credit score increase.
3. Tenure and credit mix
The length of your credit history and the variety of credit accounts you hold also impact your credit score. A personal loan with a longer tenure can positively contribute to your credit score, as it demonstrates your ability to manage long-term debt responsibly. Additionally, having a diverse credit mix that includes instalment loans like personal loans, alongside credit cards and other types of loans, can reflect favourably on your creditworthiness.
4. Credit enquiries
Whenever you apply for a personal loan, the lender performs a hard enquiry on your credit report. Multiple hard enquiries within a short period can lower your credit score.
A personal loan can significantly influence your credit score. Timely repayment, responsible credit utilisation, and maintaining a diverse credit mix are key to maintaining a healthy credit score. Remember that a good credit score can unlock various financial opportunities, including access to better interest rates and higher loan amounts.
If you are looking to build a good credit score, consider exploring the Credit Pass, a unique offering by Bajaj Finserv. It is designed to help individuals build or improve their credit score effectively by offering them real-time access to their Credit Health Report, CIBIL Score checks every month, and interactive tools that allow informed decision-making. By making the most of Credit Pass benefits, you can enhance your creditworthiness in no time.
