Credit is extremely important for achieving many of your goals and sail through the phases of emergencies that can be caused due to a number of reasons. To attain the right credit at the right time, having a good credit score is imperative. Credit Score is all about your behavior with credit.
Your credit score is affected by each and every credit related action of yours. It starts right with your application to credit and continues with each of your repayment till the closure of the credit instrument. All actions bear a positive or negative effect on your credit score depending upon how you have behaved with credit.
Loan is an important form of credit along with credit cards, overdrafts, line of credit, payday loans, etc. So, it is wrong to construe that loans can hurt your credit score. Remember that without any credit, you won't even have a credit score. And like a chicken and egg situation, without credit score, it may be difficult to get credit. However, off late, there are a numerous options available for those who would like to avail credit but do not have a credit history. But, there can be certain situations where loans could have a negative effect on your credit score.
Determinants of Your Credit Score
A credit score is assigned based on many factors of your credit behavior. Before learning how availing loans impact your credit score, it is important to know the various factors that determine your credit score.
Your Credit Accounts: The number of loan and credit card accounts that you have and if they are considered positive or negative accounts.
Repayments on your Credit Accounts: Prompt repayments on your credit accounts is one of the main components of a credit score.
Credit Mix: A good balance of secured and unsecured accounts is the cornerstone of a good credit score.
Credit History: A good and a long credit relationship does a lot of good work for your credit score. Those who are new to credit will need to build it up slowly and steadily.
Credit Utilisation Ratio: The utilization of your credit card matters a lot. The ratio of utilization to your credit limit should not exceed the prescribed limit of 30-40%. This demonstrates that you are not a credit hungry person.
Number of Hard inquiries: Each application for credit is a hard inquire. The more the number of hard inquiries in a short period of time, the lower your score can go.
Loans and Your Credit Score
Now that you know what factors affect your credit score, let us look at how applying for loans affects each of these components.
Applying for a Loan
The need for credit can come up anytime; it may be for meeting expenses like medical emergency, wedding, holiday or just a little cash crunch at the end of the month. Or it may be a planned purchase of an asset like a home or vehicle or even a gadget. There are various types of loans that are meant to cater to different kinds of scenarios.
There is no single rule that defines the number of times you should or should not apply for credit in a particular period of time. Ideally, it should be only when you need credit should you be applying for credit.
Try and analyze what happens when you take a lot of loans. When you take a lot of loans, that translates into a number of hard inquiries and if it is in a very short period of time, your credit score will go down due to an increased number of hard inquiries.
So, if you need to apply for multiple loans, try and space it out as much as possible so that your credit score is not impacted. And before signing on that loan application, make sure you really need to apply for that credit.
Repayments on your loan is one of the main determinants of your credit score. Past behavior with credit is what sets the tone for your future credit healthiness.
When you apply for a number of loans, you should bear in mind that you would need to do the repayments as well on time without fail. As the number of loans increases, it will obviously be a drain on your financial resources to be making so many EMI payments. After all, each of them has an interest component attached to them.
Did you know that for certain loans, especially big-ticket and long-term loans like home loans, you end paying the amount as much or even greater than your principal amount towards interest?
With increased number of loans, it is very easy to slip up on your EMI payments. When you start making late payments or default on your loan repayments, that is when the trouble starts with calls and emails from your lender(s), constant intimations from recovery agents, your credit score going lower and then your future chances of credit being affected.
There is no single ideal number that can be attached to the maximum number of loans a person can have. It should always be in sync with your income, other running credit accounts and the need for credit.
Credit Mix is a term that stands for the mix of credit that you have in your overall credit portfolio. They consist of secured loans like home loan, vehicle loan and loans against assets like gold, property or Fixed Deposit. On the other hand, there are unsecured borrowings or credit like personal loans and credit cards that are not backed by any asset.
A lender likes to lend to those individuals who have a healthy mix of both, which signifies that the borrower does not borrow just for spending but is also creating assets out of the borrowed money (Homes, A higher degree, etc). A borrower who has more number of unsecured borrowings often comes across as a credit hungry person and does not make for an ideal candidate for lending.
So, when you apply for too many loans, the kind of loan being applied for matters a lot. If there is a good mix of secured and unsecured borrowings, then it should not affect your credit score. However, if it is a personal loan that you are frequently applying for, then it surely strikes a wrong note and impacts your credit score.
We mentioned earlier that some kind of credit is essential for building your credit history. Loans will definitely help you build a credit score. But applying for loans just to start off your credit history may not be a very good idea. It may be good to apply for a small loan and show responsibility towards that single loan.
Are you an individual who is new to credit and is looking for a loan? We have some options to cater to individuals like you. Check here to learn more on how we can help you.
When it comes to credit, the single important point of advice, we at CreditMantri, would like to give you as your Credit Coach is that apply for credit only when it is needed and be responsible towards it till the last EMI payment.