Loans can be a daunting but necessary tool to use, especially in our current climate. But do they improve or worsen your credit score? The truth is, it could be either.
If you take out a loan and do not pay it back on time or default on it, your credit score is worsened. However, nowadays, more and more people are taking out loans and credit cards to increase their credit rating. If you make successful payments on a loan, over time it increases your credit rating. Here is the how and why of credit scores broken down.
What is a Credit Score?
Credit is the agreement between two parties. The lender agrees to give the borrower, a certain amount of money or resources to be paid back at a later date. Your credit score is a numerical representation of how likely you are to be able to pay that money back, or your ‘creditworthiness’. Companies usually use outsourced credit bureaus to look at your history of borrowing. How much you borrowed and if you made payments on time, or how late they were. Once they have done this, you are given your credit score.
This score is used by banks and loan companies to figure out if you are eligible to borrow money. Be that a personal loan, a credit card, a business loan or a mortgage.
Your credit score can also be negatively affected if you just don’t buy anything. If you never have a phone contract or direct debits to pay, you might find, when you do come to check your credit rating, that it is less than desirable.
What Can You Do to Increase your Credit Rating?
This is where loans come into play. If you take out a small repayment loan, it can actually increase your credit rating. The trick is to pay it back each payday. The algorithm on the credit score websites sees that you are being good and paying off any credit owed. However, if you miss a repayment it can negatively affect your score, so be careful and certain that you will be able to pay it back.
Payday Loans and Credit Scores
If you already have a poor credit score, you can opt for a payday loan. Payday loans have a very high APR (Annual Percentage Rate), often around 1.500%. This means you have to be very careful to make payments on time otherwise you can get into a lot of debt very quickly. Payday loans can also affect your credit score both negatively, if you miss payments, and positively if you don’t. However, this is not always the case. Often lenders who provide Payday loans do not report them to the credit bureaus. This means that they don’t usually count towards your credit mix and therefore won’t negatively impact your credit score as long as you keep paying it off.
We hope that we have answered some of your questions and that you are on your way to understanding how loans affect your credit score.