• June 17, 2021
  • Adrina Martinez

Loan and credit score are strongly associated with each other. During the application of a loan, a lender always looks at the borrower's credit score. A credit score represents repayment history, whether defaulter or not, and reflects his ability to borrow a particular amount.

Apart from these, a good credit score always represents a stable source of income and makes the lender believe in the borrower's repayment ability. Therefore, it is not difficult to understand how an ongoing loan can affect building the score. Generally, people commonly opt for a personal loan because it serves the urgency of almost every type of fund requirement.

Here we will discuss how borrowing a personal loan can affect one's credit score.

Before we begin with the affecting factor, let us know how the credit score is calculated.

  • Calculation of credit score:

Usually, lenders use different methods during the calculation of credit score. Among them, the most popular one is FICO. Fair Isaac Corporation generates it. The best credit score as per the FICO always stands between 350 and 850. However, the score is calculated on the basis of 5 important facts. They are:

  • Previous payment background – Almost 30% of the score relies upon previous payment background.
  • Pending amount of debt – Another 35% of the score goes under the pending amount of debt of a borrower. For this reason, a person should apply for a second loan only after the completion of the first one.
  • Tenure of repayment – Suppose a borrower has repaid a small loan amount throughout the maximum repayment period, then it will be considered negative repayment. However, 20% of the score depends upon the time taken for repayment.
  • Newly applied loan – Based upon the previous scores now, the amount of newly applied loan depends. The amount to be sanctioned strongly relies upon the score gathered at this step. 10% of credit score comes from this factor.
  • Credit mix – However, the remaining 10% of the score depends upon credit mix, such as types of credit facilities enjoyed by the borrower.

Apart from FICO, three major credit score analysing bureaus are Equifax, Experian and TransUnion. However, there may be differences in calculating credit score by these analysers.

  • Application for a new loan can affect credit score:

Therefore, it is now clear to you how a previous borrowing amount and a new loan application can affect your credit score. Whether you are applying for unemployed loans or personal loans, it is clear that it will affect the credit score and enhance the amount of debt in the market. Whenever you apply for a new loan, the financial agency will ask for a credit check so that they can understand whether there is any ongoing loan or not.

For example, if you want to buy a car in loan, then after applying for an auto loan, when the credit bureau goes through a score check, it will reflect her current outstanding, and if the amount is high, then your auto loan can be cancelled at any time.

On the other hand, it has been witnessed that even after possessing a good amount of outstanding new loan is sanctioned. One and the only reason behind it is timely repayment of the borrower, which leaves a good impression on the credit score

  • Borrowing a personal loan can improve the credit score:

By borrowing a personal loan, a borrower can mitigate different requirement of the fund. Moreover, people who don't have good credit scores due to never applying for loans or holding no credit cards can also improve their score. A personal loan is a type of borrowing that helps a borrower in several ways apart from the monetary requirement.

A personal loan comes with attractive features like a monthly repayment facility, a comparatively low-interest rate, pre-settlement of loan, and flexibility in choosing tenure and debt consolidation. With such a relaxing repayment method generally, no borrowers fail to complete entire dues, and in this way, with timely repayment, the credit score can be easily improved.

Timely repayment represents the punctuality of a borrower, and for this reason, money lenders would like to aid you money. People who never applied for loans can also use personal loans to build credit scores, as many direct lenders who provide this loan do not perform long verification processes. Therefore, they can use a personal loan as a stepping stone to borrow a huge amount of business loan.

  • Score that helps to become eligible for a personal loan:

As mentioned above, a borrower should achieve a certain number before being eligible for any type of loan. It is undeniable that a high credit score always helps in becoming eligible for a good amount.

  • >500 credit score is considered a poor one.
  • 550-650 is considered fair enough.
  • 670-700 is also taken as a good credit score.
  • <750-800 can be considered as a very good credit score.

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