How does taking a personal loan affect your credit score?

A personal loan can be a practical financial tool to cover unexpected expenses. It can also be used to finance significant purchases, such as a car, or to consolidate debts. However, like any credit product, it requires repayment of the borrowed amount along with added interest. Therefore, it is essential to carefully evaluate your financial situation before taking on additional debt. How you manage a personal loan can influence your credit score both positively and negatively.

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A credit score is a numerical representation of your creditworthiness, typically ranging between 0 and 1,200 in Australia. It reflects factors like your repayment history, credit inquiries, and the types of credit accounts you hold. Lenders use your credit score to evaluate the risk of lending to you, which can influence your ability to borrow and the interest rates you’re offered.

Applying for a personal loan can affect your credit score in several ways, with the purpose, amount, and term of the loan all playing a part. When a lender requests your permission to access your credit file, it may affect your credit score as it’s marked on your credit history.

If you check your credit report, you’ll find that any lender you’ve applied for credit with has reported the application to the credit bureau. This means that your credit score can also be affected if you’re frequently applying for loans, often within a short duration and, in particular, soon after a previous credit application has been rejected. Such incidents can affect your credit score negatively.

On the other hand, a personal loan can help you consolidate your debts or reduce your overall debt burden by helping you pay off a higher-interest loan or credit card. Even if this is the purpose of your personal loan, applying for it will leave a mark on your credit file. Still, reducing or eliminating debt can help you improve your credit score over time.

When managed well, a personal loan could help improve your credit score:

• ​​If you’re juggling multiple debts, consolidating them into a single personal loan can help you manage your finances better. By consolidating these debts into one personal loan, or considering alternatives like a balance transfer credit card, you can simplify your repayments and work towards clearing your debt within a set term.
• Making consistent, on-time repayments on your loan helps build a positive repayment history, boosting your credit score over time.

While a personal loan could help you meet a financial need, it may harm your credit score under certain circumstances:

• A personal loan is just another type of loan that needs to be repaid with added interest. Failure to make repayments on time can lead to negative entries on your credit report and lower your score.
• Every credit application you submit is usually recorded on your credit report and can influence your credit score. Submitting multiple personal loan applications within a short period could negatively impact your credit score. For instance, if your personal loan application is declined, it may help to identify the reasons for the rejection and address any issues before applying again.

Simply put, the way you manage your personal loan can impact your credit score positively or negatively. While making regular repayments can help boost your credit score, failing to meet your repayments can have the reverse effect.

It’s also worth keeping in mind that taking out a personal loan isn’t exactly a solution for a bad credit score. You could, for instance, work on ensuring you earn a steady income and pay your bills or other debt instalments on time. You could also speak to a financial advisor to see if you’ve missed any alternative ways of recovering from excessive debt or bad credit.