How Loans & Credit Scores Go Hand in Hand

Understanding credit and credit scores are sometimes tricky because there are a variety of factors that comprise a credit score. Loans are a significant factor that influences your credit, and in this article, we look at how and why that is.

What Is A Loan?

According to a credit repair Austin company, a loan is money that a lender gives to a borrower who promises to repay it in a specified time. When you get a loan from a bank or creditor, you sign a contract that stipulates details like the repayment schedule and interest rates.

When a person has good credit, what it means is that they’ve demonstrated responsibility in paying back money loaned to them. Payment history comprises 35% of your credit score, which is why you must make payments on time every time.

How Loans Impact Your Credit

Having said that payment history affects your credit score, you may be surprised to learn that just applying for a loan also impacts your score. How? Ten percent of your credit score is based on how many applications you make to obtain credit.

When you apply for a loan or credit card, the lender makes what’s known as a hard inquiry or hard pull to your credit. A hard inquiry means they look at your credit to check your payment history and decide whether or not to lend you money.

If:

You have multiple hard inquiries to your credit report, some lenders see you as a high-risk customer because they assume you’re short on cash and need fast credit.

Loan Payments & Credit Scores

If you get approved for a loan, you must make every payment on time until it’s paid off to maintain good credit. As mentioned above, payment history makes up 35% of your credit score, and it’s the most critical factor.

Even if you miss a payment by a few days, your score can drop a few points. To make matters worse, it can take months to build a credit score back up from a few late payments.

High Balances & Credit Scores

Another factor to impact your credit score regarding loans is the balance you carry. Lenders look at the amount of debt you owe to determine the risk factor when lending you money. If you have high balances, work hard to pay them off as quickly as possible to boost your credit score.

Also, related to balance is the credit to income ratio.

For example, if you make $5,000 per month and have payments totaling $1,500 per month, you have a debt to income ratio of 30%. While there is no ideal number for income to debt ratio, many experts say 36% or lower is good.

Most of us rely on loans to make high-dollar purchases such as homes and vehicles, so it’s essential to be smart about loans and how they relate to your credit score. Remember to always make payments on time and to work hard to pay off balances quickly.

Maintaining a good credit score not only increases the chance of getting loans and credit, but it also makes it more likely you’ll get those on favorable terms.