In order to accomplish many of your goals and get through any emergency situations that may arise for many reasons, credit is crucial. Having a strong credit score is essential for getting the correct credit when you need it. Your credit score is entirely based on your credit conduct.
Each and every action you do linked to credit has an impact on your credit score. It begins as soon as you apply for credit and lasts through the completion of all repayments on the loan instrument. Depending on how you’ve handled credit in the past, every activity has a favorable or negative impact on your credit score. Loans are a crucial type of credit, alongside credit cards, overdrafts, lines of credit, payday loans, etc. The idea that loans might lower your credit score is therefore false. Just keep in mind that you won’t even have a credit score if you don’t have any credit. Additionally, without a credit score, obtaining credit may be challenging, just like the chicken-and-egg scenario. But as of late, folks who want to use credit but lack a credit history have a wide range of possibilities.
The 5 Factors that Make Up Your Credit Score
- Payment History – Weight: 35%
Payment history defines how consistently you’ve made your payments on time. This is the most important contributor to your credit score.
- Amounts You Owe – Weight: 30%
The amounts you owe is the outstanding debt you currently owe. The lower the amount of outstanding debt, the higher the credit score.
- Length of Your Credit History – Weight: 15%
Your credit history is based on the length of time you’ve had credit accounts open in your name. A longer credit history can help your credit score. If you’ve had a credit card open for a long time, it makes good sense to continue using that card responsibly to maintain a good score.
- New Credit You Apply For – Weight: 10%
Also known as credit inquiries, the pursuit of new credit negatively affects your score.
Every time you apply for credit, your score goes down. There is one exception: when you’re shopping for a mortgage, student or auto loan, credit scoring models only count one inquiry if your comparison shopping with multiple lenders is done within a 14- to 45-day period.
For example, if you’re shopping for a car and apply for financing at three different car dealerships, your score will not decrease three times; it will only decrease once during the shopping window. That could vary depending on the type of loan you’re seeking and the credit scoring model used. Note that inquiries will affect your credit even if you’re denied or ultimately decide against the loan or credit card. Each inquiry affects most people’s score by less than 5 points and can stay on your report for up to 24 months.
- Types of Credit You Use – Weight: 10%
Your score can increase if you responsibly use different types of credit, such as installment and revolving debt. Even so, it’s not necessary to have many different types of credit in order to have a good score.
The Impact of Loan Applications on each of these Factors
- Applying for a Loan
Credit may be required at any moment to cover costs such as those related to a wedding, vacation, or even a little financial shortage at the end of the month. Or it might be a planned acquisition of a valuable item like a house, car, or even a piece of technology. Loans come in a variety of forms that are designed to fit particular situations.
The number of times you should or shouldn’t apply for credit during a specific time period is not governed by a single guideline. In an ideal world, you should only apply for credit when you actually need it. Analyze the effects of taking out a lot of loans. If you take on a lot of debt, it will result in a lot of hard inquiries, which will lower your credit score if it happens quickly.
Therefore, if you need to apply for several loans, attempt to spread them out as much as you can to avoid having an influence on your credit score. Make sure you truly need the credit before signing the loan application.
- History of Credit
We already stated how important credit is for establishing your credit history. You can surely increase your credit score using loans. However, it might not be a smart idea to just apply for loans to establish your credit. Applying for a little loan and being accountable for just that one debt may be beneficial.
- Mix of Credit
The phrase “credit mix” refers to the variety of credit that you have in your entire credit portfolio. They include secured loans like mortgages, car loans, and loans secured by fixed-rate investments like gold, real estate, or gold. Unsecured borrowings or credit, such as credit cards and personal loans, are those that are not secured by any kind of asset. Lenders like to work with borrowers who have a good balance of both since this shows that the borrower is not just using the funds for their immediate needs but is also using them to build assets.
The more unsecured loans a borrower has, the more likely it is that they are credit-hungry and so not a good prospect for lending. Determining the type of loan you’re applying for is crucial when you apply for too many loans. Your credit score shouldn’t be impacted if you have a healthy balance of secured and unsecured borrowings.
- Repayments of Loan
One of the key factors affecting your credit score is loan repayment history. Your current credit health is mostly determined by your past credit conduct.
You should keep in mind that you will need to make all of your loan repayments on time and without fail when you apply for a lot of loans. Naturally, having to pay so many EMIs as the number of loans rises would be a strain on your finances. After all, each of them is connected to an interest component. You may wind up paying a sum equal to or even higher than your original amount toward interest for some loans, particularly large-scale and long-term loans like house loans. It is incredibly simple to get behind on your EMI payments when you have a lot more debts.
When you begin making late payments or fail to make loan repayments on time, difficulty ensues, including phone calls and emails from your lender(s), frequent notifications from collection agents, a decline in your credit score, and therefore lowered prospects of obtaining credit in the future. The greatest amount of debts a person can have cannot be quantified by a single ideal number. It must always be in line with your income, active credit accounts, and credit needs.