Credit Score is an important consideration when making an application for a personal loan. It is used by lenders to determine if an applicant will be capable of repaying the loan. A higher score showcases the responsible financial behaviour of an individual. The lower the score, the harder it may become to borrow funds. Being aware of how a credit score affects loan applications can help people make better-informed financial decisions. When a personal loan is applied for, lenders utilise the credit score to determine loan eligibility, interest rates, and repayment terms. This article explains why a credit score is required for a personal loan application and how borrowers can have good credit.
What is a Credit Score?
A credit score is a three-digit number which reflects the creditworthiness of an individual. It is calculated based on such factors as repayment track record, credit utilisation, credit history length, types of credit utilised, and new credit inquiries. Credit scores range from 300 to 900. The greater the score, the greater the likelihood of securing a loan with good terms.
Why Credit Score Matters for a Personal Loan?
Credit score matters while applying for a personal loan for various reasons. Some of them are:
Impacts on Personal Loan Interest Rate
A credit score affects the interest rate of a personal loan. High-score borrowers can obtain lower interest rates, which minimises the overall cost of the loan. Low-scoring borrowers may be charged higher interest rates, which increases the burden of repayment. Personal loans being unsecured, lenders view the credit score as a deciding factor for assessing the risk of lending to the applicant.
Determines Loan Eligibility
Lenders verify credit scores before approving a personal loan application. The higher the credit score, the better the chances of approval and a lower score may result in rejection. A good credit history can enhance loan eligibility. A low score indicates to lenders that a borrower may have trouble with repayments, and thus approval becomes difficult.
Affects Loan Amount and Tenure
Lenders might provide larger amounts of loans and negotiable terms of repayment for people with good credit scores. A low credit score could affect loan quantity or lead to a shorter payback period. This implies that people with unfavourable scores may receive a lesser amount of funds or more stringent repayment terms.
Avoid Rejection and Credit Report Damage
Several rejections of loans can also decrease a credit score. Loan applications with a low credit score are more prone to rejection, which results in difficulty in obtaining credit in the future. A rejection for each application is marked in the credit report, which can discourage other lenders from sanctioning a loan.
How to Improve Credit Score for a Personal Loan?
Borrowers can use the tips mentioned to improve their credit scores.
Pay Bills on Time
Regular payment of credit card dues, loan EMIs, and bills can assist in maintaining a healthy credit score. Payment defaults lower the score. Regular payment of dues on time establishes a good credit history and can increase the chances of borrowing.
Have a Low Credit Utilisation Ratio
Using a high percentage of available credit can lower the credit score. Keeping credit utilisation below 30% of the total credit limit is a. Borrowers who frequently use a large portion of their credit limit may be seen as financially overextended.
Have a Credit Mix
Maintaining a good balance of secured and unsecured loans can help in maintaining the credit score. Proper management of various forms of credit indicates stability in finances. Lenders prefer to lend capital to borrowers who have successfully managed credit cards and loans in the past.
Impact of Low Credit Score on Various Factors of a Personal Loan
Individuals who apply with a poor credit score may face the following issues:
- Higher Interest Rates
Lenders can increase personal loan interest rates for poor credit score applicants to offset the risk. Furthermore, borrowers with a bad score may have to pay more for the loan.
- Requirement for Collateral or Guarantor
Certain lenders can request a guarantor or collateral to grant a loan when the credit score is poor. This ensures that the lender is secure in case the borrower does not make repayments.
- Restricted Loan Amount
Those with lower scores might not be approved for large loans, limiting their borrowing potential. A lower threshold means they may have to request many lenders to obtain the required funds.
Conclusion
A credit score is of vital importance when applying for personal loans. It influences loan approval, interest rates, loan amounts, and repayment periods. A high score improves the possibility of securing a personal loan with favourable terms. Timely payment of bills, low credit utilisation, refraining from multiple loan applications, and checking credit reports can enhance the score. Before applying for a personal loan, the borrower should check their credit score and, if necessary, take steps to improve it. If borrowers can maintain a good rating, they can acquire personal loans at reasonable interest rates and avoid any further financial troubles.
Eamon