How loans can affect your credit score

Loans are valuable financial tools that can help you pay for almost anything, from a home or car to a business or emergency medical bills. But what impact do loans have on your credit score?

After all, your credit score is essential to qualify for loans in the first place, along with other credit products. The three digits that make up your credit score help determine the loans and credit cards you can get and the interest rates you'll pay. Your credit score may even impact your employment, rental opportunities and insurance premiums.

The importance of a good credit score cannot be understated. If you have poor credit or not enough there are credit repair experts ready and willing to help you right now. 

Here's how loans can positively or negatively affect your credit score.

How loans can impact your credit score

Mortgage, student, personal and other types of loans can influence your credit score in several ways, including the following:

• Making consistent on-time payments can help build and maintain a healthy credit score. By contrast, late or missing payments can harm it. That's because your payment history is the most important factor in your credit score, making up a hefty 35% of your FICO Score.
• Some loans can help you get started with credit. Student loans help many graduates develop their first credit score. Credit-builder loans may also help people with little or no credit history build enough credit for the three major credit bureaus—Equifax, Experian and TransUnion—to generate a credit score. 
• A loan may diversify your credit mix. High credit scorers tend to carry a diverse portfolio of credit accounts, which could include a credit card, student loan, and other credit products. For example, having a credit card, car loan, and student loan is usually better for your credit than owning three credit cards. Your credit mix accounts for 10% of your FICO credit score.
• A loan may improve your length of credit history. How long you've had open credit accounts makes up 15% of your credit score. Typically, the longer your credit history, the better it is for your credit score. Mortgages, student loans and other loans with long repayment terms may lengthen the age of your credit history as well as the average age of your credit accounts, both of which may help your score.

If you have poor credit or want to boost your existing score higher, there are steps you can take now. 

Advantages and disadvantages of loans

It's generally not a good idea to take out a loan strictly to help you build credit. You should have a legitimate need for any loan you're considering. If you're thinking about applying for a new loan, be aware of the pros and cons before making a decision.

Loan advantages

• Loans can help you achieve financial goals like owning a home or a car.
• Making consistent on-time loan payments will help you build and maintain a strong credit score.
• Loans can help you get money for almost any purpose, from consolidating credit card debt to financing a major home renovation.
• If you have insufficient funds in your emergency savings, personal loans can help you cover your bills if you suffer a significant financial setback, like a loss of income or unexpected medical bills.

Loan disadvantages

• When you take out a loan, you incur debt, potentially leading to stress and limited financial options if you don't manage the debt responsibly.
• Virtually all loans come with interest rates, which is the amount the lender charges you to borrow money (typically a percentage of the loan principal).
• Mismanaging debt can have dire consequences. For example, if you default on a home loan, the bank can foreclose on your house. Not only will you lose your home, but having derogatory marks like a foreclosure, bankruptcy or repossession on your credit report can severely harm your credit score for seven to 10 years.
• Even one 30-day late payment can harm your credit. While a 30-day late payment won't hurt your credit score as much as more serious derogatory marks, the incident will remain on your credit report for seven years.

Stay on top of your credit by regularly reviewing your credit report for errors or fraudulent information. Additionally, check your credit score periodically to see how your actions impact your credit. And if you want to work on improving it, get started today. 

How to maintain healthy credit and a strong credit score

Building and maintaining good credit is vital to your overall financial health. Keep the following best practices in mind to help you maintain strong credit.

Pay your bills on time

Consider setting up automatic payments or alerts on your smartphone to make sure you never miss a loan payment. As mentioned, your payment history is the most important factor in your credit score. Consistent on-time payments may positively affect your credit score, while late or missing payments can have serious consequences.

Maintain low credit card balances

Your credit utilization rate—how much of your available revolving credit you're using—is the second most important factor in your credit score, accounting for 30% of your score. While credit experts generally recommend keeping your utilization rate below 30%, people with high credit scores often have credit utilization rates under 10%. In that case, if you have a credit card with a $1,000 credit limit, you should aim to keep your balance below $100 on the card.

Be mindful of hard inquiries

When you apply for a new loan or credit card, the lender or company performs what is called a "hard inquiry" of your credit report to review your credit history and determine your creditworthiness. A hard inquiry can cause a temporary dip in your credit score of five points or less, according to FICO. Before applying for a loan, check to see if the lender offers a prequalification option. Prequalification requires only a soft credit check, so you can see if you're likely to be approved for a loan without hurting your credit.

If you don't have a substantial credit history and thus need to boost your score there are reliable methods to employ. This includes:

• Applying for - and using - a secured credit card. The card issuer will ask for a deposit (think $50-$300). That amount becomes your credit limit. Then use the card as you would a traditional one. Just make sure to pay the amount off each month. That will help build your history and improve your score.
• Become an authorized user on someone else's card. A relative or friend can add you as a user on their card and you can get the benefits of their credit history. Just make sure the person whose account you're added to makes their payments on time and doesn't exhibit poor credit activity.
• Get a co-signer for a loan. This works similarly to becoming an authorized user. You can benefit from someone else's positive credit history by adding them as co-signer for a loan you take out. It's best to choose someone with a high credit score and clean credit background.

Have additional questions about your credit score and ways to boost it higher? Get in touch with an experienced credit repair expert who can help.