The banking and financial services industry has undergone a massive transformation in the past decade. Availing a personal loan in the contemporary era is far easier than it was a decade ago. Have you ever wondered what effect a small loan can have on your credit score? Well, to give you an idea, it’s not small at all but if you are punctual with the repayments, it will act in your favour.
The CIBIL Approach
So how does it all function? How do companies keep track of your loan & repayment history? Well, most companies do not have a very far-fetched approach. They rely on your CIBIL score to determine whether you are a good debtor or a bad one, yes, it’s that simple for them! So, what exactly is a CIBIL score and how does it impact your creditability?
A CIBIL report is a comprehensive report of your credit score based on an analysis of your historical credit record. It assigns a numeric value for a debtor which can be used to assess whether the debtor has a good credit history or a bad one. The credit score usually varies in the range of 300 to 900, 900 is assigned to people with maximum creditworthiness and 300 for the least creditworthiness. A higher CIBIL score can help you obtain an instant loan.
Understanding Personal Loans
So, what exactly is a personal loan? Personal loans are loans given to people without any specific intent or purpose. Personal loans are categorised under consumer loans and can be easily used for any personal purpose. To give a clear understanding of personal loan, let’s look at what usually people do with their personal loans.
Personal loans are used for various purposes such as medical bill payment, starting a venture, home renovation, etc. It’s upon the discretion of the borrower there is no specific intent listed unlike other loans such as home loans or auto loans that can be used only for specific purposes. Personal loans are usually instalment loans.
Many a time people use their personal loans to pay their short-term debt including credit card bills. People usually indulge in this activity as the rate of interest for personal loans is usually lower than that of their credit card loans. However, the interest rates are higher than that of home loans or auto loans.
One of the reasons why the interest rate for a personal loan is higher than that of your auto or home loan is because it is unsecured in nature unlike the auto or home loans. You will need to submit some collateral in case you want to obtain a home or auto loan, the risk of loaning out funds for banks or financial institutions is usually lower and that is why the interest rate charged is also low.
Calculation Of Credit Score
Taking a small loan whether it is a personal loan or a motor loan can affect your credit score either positively or negatively. Let’s understand what goes into the calculation of the credit score to have a better idea as to how small loans affect your creditworthiness and the ability to borrow money from reputed financial institutions in the future.
TransUnion CIBIL is the corporation responsible for keeping your credit files and creating a credit score based on that. The factors that are taken into consideration by the CIBIL body generally includes payment history, the amount borrowed, duration of credit, credit mix, etc. CIBIL score is the go-to option for financial firms and banks who are into the business of providing credit.
Let’s look at the individual percentage of each of the above-mentioned factors to understand what has a major and minor impact when it comes to calculating your credit score. The payment history has a major weight and constitutes around 30% of the mix. Factors like credit exposure, type and duration contribute around 50% and the remaining percentage is covered by additional factors.
How Personal Loans Can Positively Impact Your Creditworthiness?
Now that we have a fair idea about credit score, personal loan and credit score calculation, let’s delve deeper into how personal loans can positively impact your creditworthiness. Depending upon how you intend to use personal loans, you can gain a lot from it.
Improves The Credit Mix
Did you know that having multiple types of credit is good for your overall credit score and adds to your creditworthiness? Well, a personal loan can improve your credit mix to a great extent if a majority portion of your credit is revolving in nature, like a credit card.
Builds Your Payment History
One of the best things about availing a personal loan is that it can help you build a payment history that is needed by a majority of creditors when you are seeking a big loan in the future. When you are punctual with the repayment of your personal loans which are usually instalment loans, it helps to build a positive payment history and adds positively to your credit score.
Reduces Credit Utilisation Ratio
A credit utilisation ratio can be explained as the amount of revolving credit you are currently using divided by the total amount of revolving credit available for your use. Revolving credit usually entails credit cards. A personal loan is not included in your overall credit utilisation ratio.
One can easily use personal loans to pay off their credit card debt and other revolving debts. Basically, what you are doing here is replacing your revolving credit debt with instalment loans which also have a lower interest rate. This helps to boost your credit score and add positively to your overall credit history.
You can easily avail personal loans for paying off high interest debt to improve your credit history. Personal loans can also be used to take care of your costly emergencies. Before you opt for any personal loan you should keep in mind that a punctual repayment using the instalment will help to pave way for more credit lines in future and failure to do so will result in a bad credit score and closing of credit door from reputed banks and financial institutions.