Having a good credit score is important because it can play a big role in determining whether borrowers lend money to you and even what the interest rate you pay.
So how does taking out a personal loan impact your credit score?
If you were hoping for a simple answer, there isn’t really one because a personal loan could either help or hinder your credit score based on how you use it. Generally speaking though, personal loans are a form of consumer debt and are more likely to do harm than good.
We’ll explain how personal loans could help or hurt your credit report and how to manage a personal loan responsibly so you don’t inadvertently ruin your credit score.
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What is a personal loan?
At its simplest, a personal loan allows you to borrow money from a lender or financial institution for purposes such as consolidating debt, or paying for such things as a holiday or wedding, and requires you to make regular repayments over a set period of time (often seven years).
How a personal loan could help your credit score
A personal loan could potentially help your credit score if it's managed responsibly. Here’s how.
Making repayments on time
According to credit reporting agency Experian, demonstrating that you can consistently meet loan repayments over a period of time could help to establish a positive repayment history, which could help build your credit score.
This is because since July 2018, many major banks in Australia now use comprehensive credit reporting (CCR) which gives lenders a more comprehensive assessment of a borrower’s abilities by marking good habits (like making regular repayments) on a person’s credit report.
See also: What is a credit score? Does it matter?
But before taking out any form of credit such as a personal loan, make sure that you know you can afford to make the repayments in full and on time because as soon as you miss a repayment, you can be sure that will negatively impact your credit score.
How a personal loan could hurt your credit score
If you don’t manage a personal loan responsibly, you can damage your credit score. Here’s how.
Failing to make repayments on time
Even missing just one repayment will be recorded on your credit report and will negatively impact your credit score, making it harder for you to borrow money in the future. Defaulting on the loan (not being able to pay it back at all) will also have a negative impact on your credit score.
This is why it’s extremely important to work out how much you can afford to borrow and whether or not you can afford the repayments before taking out a personal loan.
Applying for too many personal loans
It’s important to shop around and compare lenders, but be very careful not to apply for too many personal loans at once as every application (also known as a hard inquiry) is recorded on your credit report. Too many hard inquiries in a short space of time can negatively impact your credit score and be a red flag for lenders.
If you’ve been rejected for a personal loan, don’t continue applying for more. Find out why your application was rejected and work on improving those issues before applying for any more loans. Often, loan rejection occurs because you don’t have a good credit score to begin with (have you ever missed a repayment or defaulted on a loan in the past?) or because the lender doesn’t think you could afford to repay the loan based on your income, expenses and debts.
Savings.com.au’s two cents
When used responsibly, personal loans could potentially help your credit score if you make repayments on time. However, it’s important to note that you don’t actually need to take out credit to build your credit score - this is a very common misconception. Simply making bill or rent payments on time can help you build up a good credit score.
If you’re not careful and don’t use personal loans responsibly, you could damage your credit score which could make it harder for you to borrow money in the future. Before taking out a personal loan, carefully weigh up the risks and consider how much you can afford to borrow and whether or not you can afford to make the repayments to decide if a personal loan is the right option for you.
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