Will paying off a personal loan increase my credit score?

Reaching the end of your loan term and making your final repayment can be a satisfying feat. But will paying off your personal loan give your credit score a boost, or could it have the opposite effect?

It may all come down to your personal credit file and the active credit products you hold. Australia’s major credit reporting bureaus, Experian, illion and Equifax, don’t disclose exactly how they calculate your credit score, but generally consider the following factors: 

• The number of credit accounts you have: This could be multiple accounts of the same type of credit (e.g. holding several credit cards), or a range of different types of credit (e.g. holding a credit card, personal loan and home loan).
• Your credit mix: This could include one or any number of instalment loans such as personal loans, car loans, and home loans, or revolving debt such as credit cards.
• Used vs available credit: Refers to revolving debt where you may only have a portion of your credit limit in use at any one time, such as a credit card.
• The length of your credit history: The age of your active credit accounts.
• Your payment history: This can include repayments, late payments, defaults, and bankruptcies.

Thanks to comprehensive credit reporting, both positive and negative credit behaviours can affect your credit score. For example, successfully applying for credit and making repayments on time could help to improve your credit score, while missed payments and defaults could increase your risk of bad credit.

Does paying off a personal loan improve my credit score?

While the act of paying off and closing a personal loan may not directly improve your credit score, clearing this debt could potentially make it easier to perform positive credit behaviours that could increase your credit score. Likewise, it could help you avoid some of the negative credit behaviours that could hurt your credit score.

For example, paying off a personal loan could mean you can redirect the money previously used for personal loan repayments elsewhere in your household budget. This could help you more comfortably pay other loans and credit accounts on time, and avoid late payments and defaults. Over time, this could lead to an increase in your credit score.

Can paying off a personal loan hurt your credit score?

One significant factor used to calculate your credit score is the length of your credit history. Credit providers generally like to see that you have a long track record of responsibly paying down your credit accounts. 

If your personal loan is your only form of credit, or your longest-held credit account, your credit score could initially take a hit when you finish paying it off and close the account. This is because when this personal loan is no longer listed as an active account, it will shorten your credit history’s length.

Similarly, if your personal loan is the only kind of credit you hold, then your credit mix could be affected and in turn affect your score.

That said, any dip in your credit score after paying off a personal loan will likely only be temporary, as new information will soon become available for credit bureaus to use when calculating your credit score.

Does applying for a personal loan help or hurt your credit score? 

If you’re on the other end of the borrowing process, you may be wondering how applying for a personal loan might affect your credit score. While simply applying for a personal loan shouldn’t hurt your credit score, it’s important to note that every application for credit will be recorded on your file as a hard enquiry when the lender runs a credit check.

If you apply for multiple personal loans at the same time, or in quick succession after being knocked back, lenders may also view this as a sign of credit stress, which could reduce your chance of approval. Having a loan rejected won’t necessarily affect your credit score, but making too many applications over a short period potentially could.

Doing your due diligence before applying for a personal loan could help you protect your credit score and avoid having your application rejected. Successfully applying for a personal loan and keeping up with the repayments on time could count as positive credit behaviour, potentially helping to improve your credit score over time.

What credit score do you need for a personal loan?

Generally, credit providers reserve their most competitive credit products for excellent credit borrowers. But that doesn’t mean you won’t be approved for a personal loan if your score is less than excellent.

Borrowers with good to excellent credit scores will typically find it easier to get approved for a personal loan compared to borrowers with fair, below average, and poor credit scores.

Similarly, those with higher ranking credit scores will typically also be offered lower interest rates and better deals than those with scores in the lower bands.

While there isn’t a specific score that will guarantee your approval for a personal loan, the higher your credit score, the more desirable you may be as a customer to lenders. 

If you have a below average credit score and time is on your side, you might like to consider working towards boosting your score before applying for a personal loan.