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How Loans Affect Your Credit Score

Posted by in Credit Score
25
Jan 2016

It is a fact of life for most people in the 21st century: at some point or another, you are going to need to borrow money in order to continue living your life. Whether it be for a house, to grow your business, for higher education to make yourself a more marketable/valuable employee, eventually we all need to take out loans.

How Loans Affect Credit Scores

Borrowing money is something to be taken seriously. Depending on how you treat and service your debts, they can have a significant impact on your credit score and future creditworthiness. Below are four ways in which loans can affect your credit.

Late repayment. If your payment is more than 30 days late, the major credit bureaus are usually notified, which means that the late payment history is going to show up on your credit report and could potentially stay there for up to seven years. Payment history usually comprises about 35% of your total credit score and is one of the major factors that goes into calculating that score. Even one late payment can have a substantial negative impact on your credit score.

Timely repayment. Timely repayment is what all borrowers should be striving for. Having a well established history of borrowing and timely repayment is a huge boon to your credit score and makes you a much more attractive borrower to future lenders. Timely repayment indicates that you are serious about repaying money you have been lent, and banks and other financial institutions take that seriously.

High-loan balances. Carrying a large balance for a long period of time has a serious effect on your credit score. Creditors want to see a history of regular repayment and dedication to paying down balances for them to feel comfortable lending you additional funds. If they feel like it is going to take them a long time to recover their investment (i.e. your creditworthiness is questionable), they will be hesitant to lend you money.

High debt-to-income ratio. Your debt to income ratio is the amount of money you owe over the amount of money you have coming in on a weekly, monthly or annual basis. Having a net positive cash flow which can easily cover the cost of your debt puts creditors at ease. It increases your creditworthiness in the eyes of lenders because they are confident that you are going to be repaying them what they are owed on a regular basis.

Taking out a loan, especially when you are starting a new, expensive and necessary chapter in your life is often unavoidable. Making sure you are not over-leveraging yourself and are bringing in enough money to service your debt when repayment is scheduled will ensure that you keep your credit rating and future ability to borrow high.

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