Will A Personal Loan Affect My Credit Score?

Will a personal loan affect my credit score?

You will probably have some familiarity with the term credit score as your credit score is checked by lenders when you apply for a wide variety of financial products, including a new mobile phone contract or credit card. Yet, you probably have not given it a lot of thought. Therefore, it is good to be aware of what exactly a credit score is and how it works, especially before you apply for a personal loan.

What is a personal loan?

A personal loan is a type of credit that can help you make larger purchases or consolidate other debts that may have a higher interest rate. A personal loan will usually have a lower interest rate than a credit card. You can use it to consolidate debt from multiple credit cards into one lower monthly repayment.

Whenever you apply for any form of credit, the lender uses several criteria to determine whether they will offer you the financial product. One of these criteria is obtaining your credit score from one of the credit reference agencies in the UK.

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Who are the credit reference agencies?

There are three main credit scoring agencies in the UK – Equifax, Experian and TransUnion (previously known as Callcredit). There is no such thing as a universal credit score. Each of the credit reference agencies uses a different scoring mechanism and scale. They all gather information from various sources, including court records, local councils and the Registry Trust.

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Your questions, answered

What is a credit score?

Your credit score not only affects your ability to take out a loan. Your credit file is also checked when you take out a mobile phone contract, for example, and is also accessed when you take out car insurance which you pay in monthly instalments, or if you want to open a new bank account. 

A good credit score shows that you are responsible for managing your money. The lender will want to see that you make payments on time and that you are a sensible borrower. The lender will use your credit score to decide if they will issue you with a loan, as this helps them determine your level of creditworthiness. A high credit score represents a lower risk to the lender as they can be more confident you will meet the repayments. A low credit score could indicate to the lender that you are more of a risk. Your credit score is calculated by the lender using data from credit reference agencies together with other information, such as your income. Different companies will consider different information when calculating your credit score. Much of this is subjective; what one lender sees as a negative another may be less of a problem. It depends on the company and what they look for in a customer. Therefore, your score will likely vary between different companies and credit reference agencies. 

If you have a little credit history or none, you may find it difficult to obtain credit as you cannot prove that you will be a responsible borrower.

What information is contained within my credit report?

You can obtain your credit report for free from any credit reference agency – you have a legal right to do so. However, they are not required to provide you with an actual credit score since this is a service provided by the agency and not part of your statutory rights.  

On your credit report, you will find a range of information. This includes any credit applications you have made over the previous 12 months. Other financial information, such as defaults on loans, county court judgements (CCJs) and bankruptcies, remain on your file for six years. Your credit report will also list your previous addresses, financial connections (people with whom you have joint financial products, such as a mortgage or bank account), and information about whether the repayments of these products are up-to-date. 

Every time you make a credit application, it is recorded on your file that you have done so. For this reason, if you are expecting to need any substantial credit soon, such as a mortgage, you should not make applications for other financial products in the preceding few months.   

To initially determine whether you may be offered a loan, many companies offer to undertake a soft search, which does not leave a mark on your credit report.

What’s good for my credit score, and what can I do to improve it?

There are several easy things you can do to improve your credit school. 

  • Ensure you are on the electoral roll, as this confirms your name and address. You can register to vote online. 
  • Demonstrate that you are financially responsible by staying up-to-date with all the repayments on your financial products. If you have a credit card that you never use, you should close the account as having access to too much credit can count against you. 
  • Regularly check your credit report to ensure no errors, such as a lender mistakenly entering the wrong information. If this is the case, contact the company and ask them to remove it.
  • If you have separated from a partner with whom you have a joint financial product, you can ask for a notice of dissociation to be added to your file. 
  • Using a personal loan to pay off a credit card can also improve your credit score. You demonstrate financial responsibility by using a low-interest rate product to pay off a higher interest product.

If you have no previous credit history, this can cause an issue as the lender has no financial information to base their decision on. In this case, consider an introductory credit card to build a credit history. These cards usually have a high-interest rate and low spending limit. However, if you make small purchases on the card and pay off the balance in full each month, you will not accrue any interest and demonstrate to future lenders that you are a responsible borrower.

What’s bad for my credit score?

Three key things are bad for your credit score:

  • Missing a repayment: Missing payments, especially if you do so multiple times, could see a default recorded on your file, which will remain there for six years. If you do not repay the debt, it could also result in a county court judgement issued against you. 
  • Reaching the limit of your credit card and at the maximum of your overdraft: Indicates that you may be struggling financially.
  • Applying for credit too often: This will record a hard search on your report, and too many applications will make it look like you are desperate for funds.

What won’t affect my credit score?

Things that won’t affect your credit score include:

  • Debt accumulated by anyone previously living in your property: Your credit score is based on you and anyone you have financial links with, such as a shared bank account or mortgage.
  • Debts older than six years: After six years, the debt will drop off your report
  • Checking your credit score: This does not appear on your credit report, and the same goes for soft checks made by a lender to check your eligibility before you make an actual application
  • Credit blacklist: There is no such thing as a credit blacklist or a centralised database of risky borrowers.

Will a personal loan affect my credit score?

A personal loan can help your credit score in many ways. Loans help you build a good payment history if you always make your repayments on time. Therefore, you should ensure that you can meet the payments in full every month when taking out the loan. If you make all of your payments on time and do not default on the loan, it shows future credit providers that you are trustworthy and can meet the repayments. 

A personal loan will harm your credit score in the very short term simply by taking one out. However, if you make your repayments on time, your score will quickly improve because you prove that you are a responsible borrower. Of course, this also means that if you make a late payment or default on the loan, this will hurt your credit score. Also, bear in mind that successive applications for credit are a bad thing. Therefore, if you are planning on taking out a mortgage soon, it is best not to take out a personal loan around the same time.

A personal loan will ultimately be good for your credit score if you are a sensible borrower. Sensible borrowing is simply ensuring that you do not borrow more money than you can afford to pay back.

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