A loan is the act of acquiring money from another party with an agreement that the sum of money borrowed is paid in full with interest. Typically, loans require fixed payments of a certain amount on a particular date over a certain period of time until the entire debt, including the interest, is paid in full
Generally speaking, lenders will approve the loan when you have good credit since this is an indicator that you have good spending habits and you are able to repay your financial obligations on time. Bad credit, however, indicates that you are less than likely to repay your bills on time or at all.
The act of acquiring a loan and how you pay back that loan will have an impact on your credit score, which is a numerical representation of your credit history at that point in time.
How Loans Influence Your Credit
New credit, or the number of credit-based applications you make, comprises 10% of your credit score. This means that just applying for a loan could decrease your credit score. Each time you apply for a loan, an inquiry is made on your credit. Several inquiries, especially in a short period of time, could be an indication of financial trouble.
When you’re shopping for a mortgage or auto loan, you have a grace period in which multiple loan inquiries are counted as a single inquiry and won’t affect your credit score much. This period is typically 14 to 45 days long depending on which credit score the lender is using. Be sure to limit your loan shopping within that timeframe so as not to impact your credit score very much.
Having many credit accounts also make up 10% of your credit score. Generally speaking, having a variety of loans and credit can increase your credit score if they are paid off regularly. However, taking on too much debt in a short amount of time may lead to more financial trouble.
Improving Your Credit Score through Loans
Loan payments have a significant impact on your credit. Therefore, it is paramount that, once you’re approved for a loan, you make your monthly payments on time since payment history is 35% of your credit score.
Making on-time payments is essential and will reflect on your credit score, making you a more attractive borrower in the lender’s eyes. However, missing even a single payment could lead to further late payments, which will hurt your credit score. Worse, missing payments on a loan could lead to repossession and foreclosure of your property, hurting your credit score even further.
By continuing to make payments on your loan, your credit score increases as your balance goes down. The larger the gap between your original loan amount and your current loan balance, the better your credit score will be.