By definition, a loan consists of a sum of money given by the lender to the debtor on the basis of the borrower’s promise to repay as per a mutually agreed upon contract. Typically, the loan contract will specify the loan amount, the number of repayments of a specified amount, and the repayment schedule.
The Loan – Credit Score Relationship
The terms of the loan extended to the applicantreflect the degree of the trust reposed in the borrower’s ability to stick to the contract. When a person enjoys good credit, the terms are more favorable as the credit score is a reflection of the financial discipline demonstrated by the borrower in the past. When you take a loan, your credit score gets affected, and it also improves every time you repay a part. The reason is when you take a loan or make a payment, your debt exposure changes. The credit score also gets impacted if you make the payment late or miss the payment altogether.
Why Even a Loan Application Can Make Your Credit Score Dip
Just by making a loan application the credit score can be negatively impacted. This is because loan applications are given a 10% weight in the calculation of the credit score. Whenever you apply for a loan, the lender makes a hard inquiry on your credit score. Every credit has a negative impact on the score as it shows that you have a need of funds. If you apply to multiple lenders, the number of inquiries also increases and indicates that you may be desperate for cash.The debt to income ratio could also be adversely affected. If you have poor credit and need emergency cash, you can consider payday loan lenders as they typically do not require credit scores.
However, you should not desist from shopping for the best rates since multiple inquiries within a particular period are treated as one. The period applicable is between 14 and 45 days depending on the credit bureau receiving the inquiry.
Timely Repayments Can Boost Your Credit Score
Making your loan repayments on time has multiple benefits; not only you can avoid the extra interest and penalties associated with late payments but also give your credit score a boost, when otherwise, it would have taken a beating. Take into account that the payment history accounts for a whopping 35% weight in your final credit score. As you can appreciate, since lenders are worried about getting their money back on time, the weight assigned to punctuality is more than any other factor for calculating the credit score. Since the loan balance also influences your score, the more you repay, the better the impact on your credit.
Conclusion
While it is important to keep your credit score as high as possible by not making too many loan applications and making the repayments on time, the interest rate offered by a lender may be influenced by your debt-to-income ratio.