Personal loans can be a useful financial tool for many South Africans. A personal loan can help you reach your financial objectives. It can be used to consolidate debt, pay for unexpected expenses, or fund a large purchase. However, it is important to understand how taking out a personal loan can affect your credit score.
Your credit score is an indication of how reliable you are when it comes to paying off debt. It is calculated based on your credit history, which includes information about your credit accounts, payment history, and other factors. Your credit score is used by lenders to determine whether to approve your loan application and what interest rate to offer you.
When applying for a personal loan, a lender will use a credit check to evaluate your ability to pay back the loan. This credit check will be recorded on your credit report, which is a record of your credit history. The credit check will have a temporary negative impact on your credit score, but this impact is usually minor and short-lived.
If you are approved for a personal loan, the loan will be added to your credit report as a new credit account. This will have both positive and negative effects on your credit score.
On the positive side, taking out a personal loan can improve your credit mix. Credit mix refers to the different types of credit accounts you have, such as credit cards, car loans, and personal loans. Having a mix of different types of credit accounts can improve your credit score, as it indicates that you are able to manage different types of credit responsibly.
In addition, making your loan payments on time and in full can improve your payment history, which is the most important factor in determining your credit score. Consistently making on-time payments can demonstrate to lenders that you are a responsible borrower and can help you improve your credit score over time.
However, taking out a personal loan can also have negative effects on your credit score. One of the biggest negative effects is that it can increase your credit utilisation ratio.
Your credit utilisation ratio is the amount of credit you are using compared to the amount of credit you have available. For example, If you have a credit card with a R5,000 limit, and the balance on you card is R2,500. would mean your credit utilisation ratio is 50%.
Having a large amount of credit compared to available funds may make lenders think you are overusing credit and may not be able to pay back your debts.
It can can also increase your debt-to-income ratio. Your debt-to-income ratio is the amount of debt you have compared to your income. Financial institutions use this calculation to evaluate your capacity to fulfill their financial obligations.
Your debt-to-income ratio can affect lenders' decisions. If your credit score is too low, potential lenders may consider you a risky investment and deny you a loan.
What if I miss a repayment?
Finally, defaulting on your personal loan can have a significant negative impact on your credit score. If you are unable to make your loan payments on time, your lender may report the missed payments to the credit bureaus. This can result in a significant drop in your credit score and can make it more difficult for you to obtain credit in the future.
In conclusion, taking out a personal loan can have both positive and negative effects on your credit score. While a personal loan can improve your credit mix and payment history, it can also increase your credit utilisation ratio and debt-to-income ratio.
It is important to carefully consider the impact that taking out a personal loan will have on your credit score before applying for a loan. If you do decide to take out a personal loan, be sure to make your payments on time and in full to avoid damaging your credit score.