To understand the impact of loans on your credit score, we must first take a step back to understand the foundation of loans and credit. When someone borrows a loan, they agree to make a certain number of payments for a certain amount by a particular date each month. A credit score represents the amount of trust lenders have that someone will be able to repay their debts and financial obligations on time. A good, or higher, score suggests they are very timely with payments, whereas a bad score suggests they are not very trustworthy with repaying what is owed.
What most people don’t realize is that your loan payments and even the process of borrowing the loan has an impact on your credit score.
Loan applications can lower your credit score because 10% of your score comes from the number of credit-based applications you make. Every time you apply for credit, an inquiry is placed on your report to show that a lender has reviewed your score, thus several inquiries in a short period of time may suggest desperation. Make note that this does not apply to mortgage or auto loans due to a grace period.
Once you’re approved for a loan, it’s imperative to consistently make your monthly payments on time because history comprises 35% of your credit score. Timely payments will improve your credit score, whereas late loan payments will severely hurt your score.
The balance of your loan also has an impact on credit because you gain score points by paying that amount down. This means that the larger the gap between your original loan amount and your current loan balance, the better your credit score will be.
Although outstanding debt may not directly impact your FICO credit score, be aware that lenders consider income a factor in your ability to repay a loan. A high debt-to-income ratio may increase your risk score with a lender, ultimately causing you to be denied. Understanding how loan borrowing can impact your credit score is the first step to responsible lending habits. If you still have questions or are curious about the impact of loans on your score, don’t hesitate to call a Liberty Lending Consultant today.