Lending institutions give more importance to the credit score of borrowers when approving the loan. These days, borrowers also closely monitor the credit score and want to improve it to increase their credit worthiness for trouble-free credit. There are many ways to improve your credit score and there are also many myths about the same. Many believe that applying for a personal loan will negatively affect your credit score. This is not true, but in fact, getting a personal loan and paying it back on time can improve your credit score.
To better understand how a personal loan affects your credit score, it is important to know how your credit score works.
How does a credit score work?
In the UAE, the Al Etihad Credit Bureau (AECB) collects credit data and information from banks and financial institutions to maintain correct credit score data. The credit score is between 300 and 900 and banks prefer a credit score between 750. You can check your credit score on the official website at https://aecb.gov.ae/. There are some important factors the board takes into account when calculating a credit score. These are some of the most important factors that banks take into account when calculating the credit score that is awarded in descending order of importance.
- Borrower's credit history
- use of credit limit
- Length of credit history
- credit mix
- new credit
1. Borrower's credit history
The bank examines the borrower's credit history and then decides whether to grant a loan or not. If the borrower has taken out loans before, they were successfully liquidated and obtained a certificate of no objection from the bank.
The borrower's credit score will increase favorably and will be attractive in the eyes of the bank. Banks will be willing to make loans to these borrowers.
Suppose that if the borrower does not pay the loans on time and there are defaults, the banks will not approve the loan.
2. Take advantage of the credit limit
When calculating the credit score, the use of the credit limit is also taken into account. If the credit card holder uses more than 30% of the credit limit, there will be a direct impact on the credit score.
The credit score keeps dropping and you won't be able to get any loans. Best practice is to use a credit card within the 30% credit limit.
3. Extensive credit history
The length of your credit history is also an important factor that can affect your credit score. Suppose the borrower has been borrowing for ten years. During the ten-year period, banks will be reluctant to issue additional credit until previous loans are fully repaid and paid off.
However, this may vary from case to case if the borrower has good repayment capacity and has clear sources of income, banks can issue additional credit regardless of the length of the loan period.
4. credit mix
The credit mix includes credit obtained by the borrower from various sources such as credit cards, student loans, auto loans, home loans, home loans, and others.
If any of the lines of credit do not meet, the borrower will not be able to obtain any additional form of credit. Banks and lending institutions analyze the borrower's credit mix before issuing the loan.
5. New credit
Opening a new credit card or rather applying for a new loan will also affect your current credit score. If the borrower applies for a loan from different banks, this will have an impact on the credit rating.
Banks will verify the borrower's credit with a difficult query; Also known as hard drag. Write down the review on your credit reports and it will lower your credit score. If the credit score goes down, it becomes difficult to obtain personal loans from the bank.
After understanding how a credit score works, let's look at the impact of a personal loan on a credit score.
The effect of a personal loan on your credit score
Since a personal loan is an unsecured loan, the interest rate is very competitive and the funds can be used for any financial need. The type of loans does not affect the credit score as long as the borrower repays the personal loan on time.
If the personal loan is paid off on time, the credit score will improve favorably. If the borrower defaults on the loan, this will have a negative impact on the credit rating.
When it comes to credit rating, using a personal loan is better than using a credit card. There is no charge to use the credit limit on the personal loan, and the credit rating improves with the full payment of the loan. Other factors, such as length of credit history and credit mix, add positively to your credit score.
When the borrower applies for a new personal loan, the credit score is lowered by a very small number and this is only temporary and can be recovered within a period of time by paying off the loan. When a personal loan is paid off regularly, the credit score numbers that have been lowered will increase over a period of time.
- Obtaining an additional loan during the current loan repayment period becomes difficult.
- Your credit score will be temporarily lowered because you have debt and this is also unsecured debt.
- Paying off personal loans on time will not only increase your credit score, but you will also receive additional offers from banks.
- Applying for a personal loan and paying it off on time improves the credit rating of borrowers. If it is not repaid, it will have a negative impact on your credit score.
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