How does taking a personal loan affect my credit score?

Taking a personal loan can be a significant financial decision, and understanding its impact on your credit score is crucial for managing your overall financial health.

Your credit score plays a pivotal role in determining your eligibility for future loans and credit products, as well as the interest rates you may qualify for.

Therefore, it's essential to comprehend how a personal loan can influence your credit score.

Here are the factors that affect credit score:

Credit Inquiry:

Applying for a personal loan initiates a hard inquiry on your credit report by the lender. This hard inquiry can temporarily lower your credit score by a few points. However, the impact is usually minor and short-lived.

Credit Utilisation:

When you take out a personal loan, it increases your total available credit. If you maintain low balances on your existing credit accounts while adding a new loan, your credit utilisation ratio decreases.

A lower credit utilisation ratio can positively impact your credit score.

Payment History:

Making timely payments on your personal loan is crucial for maintaining a positive credit history.

Consistently paying your loan instalments on time demonstrates responsible borrowing behaviour and can contribute to building a good credit score.

Credit Mix:

Having a diverse mix of credit accounts, including instalment loans like personal loans, may positively influence your credit score.

Debt-to-Income Ratio:

Your debt-to-income ratio, which compares your total debt payments to your income, can affect your credit score indirectly.

Taking on additional debt through a personal loan may increase your debt-to-income ratio, potentially affecting your ability to qualify for future credit products.

While a personal loan may initially cause a temporary decrease in your credit score due to the hard inquiry and potential impact on your credit utilisation ratio, responsible borrowing and timely repayments can help improve your credit score over time.