The Impact of Personal Loans on Credit Scores: Myth vs. Reality : There are many misconceptions surrounding personal loans and their effect on credit scores. If you want to take a personal loan but are concerned about its impact on your credit score, then this article is for you.
In this article, I’ll debunk these myths and provide you with some practical tips on how to manage personal loans effectively without affecting your credit score.
Let’s separate fact from fiction.
3 Major Myths Regarding Personal Loans and Credit Scores
Myth #1: Personal Loans Can Quickly Boost Your Credit Score
While using credit cards and paying bills on time may improve your CIBIL score at a faster pace but paying personal loan EMI on time won’t give an instant boost to your credit score.
However, timely repayment of personal loans can improve your credit CIBIL score over time, it’s essential to understand that there are no overnight miracles.
Building and improving credit takes time and consistent effort. Simply obtaining a personal loan won’t result in an instant credit score boost.
Reality: It’s the responsible repayment and management of the loan that will gradually enhance your creditworthiness.
Myth #2: Personal Loans Always Hurt Your Credit Score
One common misconception is that getting a personal loan will automatically affect your credit score negatively.
Personal loans or any loan will hurt your credit score only when you won’t pay the EMI on time. Personal loans, when managed responsibly with timely EMI repayment can have a positive impact on your credit.
Reality: By making timely payments and keeping your debt utilization in check, you demonstrate good financial discipline and improve your creditworthiness.
Myth #3: Multiple Loans Are Viewed Negatively by Credit Bureaus
Contrary to popular belief, credit bureaus don’t automatically view multiple loans as negative factors.
Having multiple loans (also called a credit mix) that may include personal loans, home loans, and credit cards can positively impact your credit score. Because banks appreciate a track record of successfully managing different types of credit.
Multiple diverse credit accounts in good position show that you can handle both short-term credit (like credit cards) and long-term credit (like loans) effectively.
Reality: Multiple loans can enhance your creditworthiness and make you a more attractive borrower. What matters most is the consistent on-time payments that can boost your CIBIL score.
5 Tips for Managing Personal Loans Effectively
Now that we’ve debunked the myths let’s explore some practical tips for managing personal loans and preserving your credit score.
The best tip for managing personal loans is to educate yourself about personal finance management to avoid any mistakes that lead to monetary losses. You can watch YouTube channels, read personal finance blogs, listen to podcasts, and read books to learn effective management of your money.
Let’s discuss the 5 important tips to manage personal loans efficiently.
- Borrow What You Need: Only take out a personal loan for necessary expenses and avoid excessive borrowing. Taking on more debt than necessary can strain your finances and potentially impact your credit score.
- Make Timely Payments: Pay your loan installments on time each month. Multiple missed or late payments can have a significant negative impact on your credit score. If case of insufficient funds, I would suggest you to use your fixed deposit, withdraw unused funds from your Demat account or sell your liquid and debt mutual funds.
- Keep a Balanced Debt-to-Income Ratio: Maintain a healthy balance between your debt and income. Take a loan that you can comfortably handle, as non-repayment of EMIs can decrease your creditworthiness.
- Monitor Your Credit Report: Regularly check your credit report for accuracy and potential discrepancies. Reporting errors can harm your credit score, so it’s crucial to address them promptly.
- Consider Loan Consolidation Carefully: If you’re considering consolidating multiple loans into one personal loan, weigh the pros and cons of loan consolidation thoroughly. Loan consolidation may give a slight dip in your credit score because of a new loan but in the long run, it will positively impact your CIBIL score with timely payments.
Impact of Personal Loans on Credit Scores – Myths Vs Reality
| Myths | Reality |
|---|---|
| Personal loans always hurt your credit score. | Personal loans can have a positive impact if managed responsibly. |
| Personal loans can quickly boost your credit score. | Building credit takes time and responsible repayment habits. |
| Multiple loans are viewed negatively by credit bureaus. | Credit bureaus consider responsible loan management (timely repayment of EMI) positively. |
Conclusion
Personal loans, when used responsibly, can have a positive impact on your CIBIL score. While personal loans won’t instantly boost your credit score, they also don’t automatically harm it.
Responsible borrowing and timely repayment are key factors in building a strong credit history and improving your credit score.