Do personal loans affect your credit score?

Due to the advent of credit information bureaus, the awareness about the importance of credit history and credit score has increased substantially in the past decade. Many people are not aware of what transactions and behaviours affect your credit score. Personal loan as a product has gained popularity amongst the salaried and self-employed equally due to an increasing trend of consumerism and easy availability of personal loan in recent times. Does personal loan affects your credit score in any manner and if yes how does it impact your credit score. Let us discuss.

Importance of credit score

Since the lenders are interested in proper and timely servicing of the loan given by them they want to assure themselves in advance about the probability of the borrower defaulting on servicing of the loan taken by him. With the ready availability of the information about the financial conduct of person from data accessed from credit information bureau, the lenders have more comfort and better screening technique available with them before granting any credit facility to a prospective borrower. All the financial institutions like banks and Non-Banking Financial companies (NBFC) are mandated to share the information about the financial transactions of their customers with the credit information bureaus.  Due to such data shared with the credit information bureaus, the history and behaviour pattern of the borrower about how they conduct their financial transactions are readily available to such financial institutions. CIBIL (Credit Information Bureau of India Limited), the pioneer credit information bureau has a three digit numerical number describing a person’s financial health which is known as CIBIL score. CIBIL score of more than 750 out of the maximum of 900 is considered prima facie satisfactory a number and the substantial number of loans are given to the people who have CIBIL score of more than 750. Please note that just because you have CIBIL score of more than 750 does not always guarantee you a loan applied for. While satisfying itself about the probability of the borrower servicing the loan regularly which is predictable with the help of credit score, the lender also has to evaluate your loan eligibility in terms of amount as well as it has to evaluate the value of assets offered as security to safeguard its interest.

Since personal loans are given without obtaining any tangible security by the lender, the credit score becomes more important for the lenders to gain confidence about the financial health of the borrower. Just because the borrower has not given any tangible security, the probability of him defaulting on personal loan as compared to a home loan is higher.

How does the personal loan affect your credit score

Just because you have taken a personal loan does not have any impact on your credit score as borrowing money is normal and is generally not perceived adversely by the lenders. On the contrary, if your service the personal loan regularly it may help you improve your credit score. However persistent delays in payment of your personal loan EMIs affect your credit score adversely. However, an isolated instance of delay in payment of your personal loan EMI does not impact your credit score adversely. Likewise any default in the payment of your personal loan EMI adversely affects your credit score. Even if you settle the outstanding dues of personal loan later on where the lender has to write off part of the personal loan outstanding, it adversely affects your credit score as it reflects your inability/intention to meet your financial obligations. However, if you pay the outstanding of the personal loan together with interest fully, it will help you improve your credit score which was vitiated due to your initial default.

However, if you borrow through personal loans persistently or have more than one personal loan running parallel, it reflects badly on your financial management and may in all likelihood adversely impact your credit score. Since personal loans are given without any security the lenders are generally selective in giving it and your application may get rejected once in a while for any reason. All the applications for loans whether the personal loan or home loans whether sanctioned or not are also reported to the credit information bureau by all the financial institutions. So in case, you have made personal loan applications with many prospective lenders simultaneously or within a short span of time, it gets reflected in your credit history which is accessed by the lenders before processing your loan applications. Frequent personal loan applications in your credit history show your desperation and hunger for funds/credit and generally is adversely perceived by the lenders.

So though personal loans per se do not affect your credit score adversely but applying for personal loans with many lenders as well as availing personal loan very frequently or delays/defaults in payment of EMI reflects badly on your financial behaviour and may jeopardise your ability to avail any credit from the banking and financial system. So be careful while making application for a personal loan. Try to balance your budget so as not having to avail personal loan too frequently.

People generally perceive that if you prepay your outstanding personal loan before its tenure it adversely affects your credit score adversely. This is not correct and on the contrary prepayment of a personal loan before the tenure of the loan shows to the lender that you are able to manage your debt will and behave responsibly with your debt obligations.