Fullerton India Credit Co. Ltd. is Now SMFG India Credit Co. Ltd.

Enhancing Credit Scores through Personal Loans: Myth or Reality?

Published on Apr 3, 2024Updated on Apr 5, 2024

Enhancing Credit Scores through Personal Loans: Myth or Reality?

Does taking out a personal loan hurt your credit score? Or will a personal loan quickly fix your credit score?

With credit score being one of the most crucial factors in the personal loan application process, there are naturally many myths and doubts surrounding them. Let’s help you uncover the most common credit score myths and the truth behind them. We will also take a look at some ways to maximize the benefits of your personal loan for credit score enhancement.

What is a Credit Score? Why is it important?

A credit score, also commonly known as a CIBIL (Credit Information Bureau India Ltd.) score is a 3-digit value that is a summary of your complete credit history. It is derived from factors like your payment history on credit cards or loans, outstanding debt if any, length of credit history, and so on. In India, credit scores typically range from 300 to 900. A score of 700 to 749 is usually considered a “good credit score” while scores of 750 and above are considered “excellent”.

When you apply for a personal loan or credit card, lenders will turn to credit scores to assess how likely you are to repay the loan on time. Borrowers with higher scores are often viewed as low-risk and can be offered lower interest rates and larger loan amounts. They may also get a longer repayment tenure, reducing the burden on monthly installments.

Common Misconceptions about the Impact of Personal Loans on Credit Scores

There are several on how both of these factors affect each other. Here are some of the most common personal loan myths -

  • Taking out a personal loan will have a negative impact on your credit score.
  • A personal loan is a quick way to improve CIBIL score.
  • A high credit score is a guarantee for personal loan approval.
  • A higher income will make up for a lower credit score.

Debunking the Common Myths Surrounding Personal Loans and Credit Scores

Myth 1. Taking out a Personal Loan always hurts your Credit Score

When you apply for a personal loan, lenders will initiate a hard inquiry on your credit report. This may cause a small decrease in your credit score, but it is usually only for a short term. If you make sure of timely payment of the loan instalments, you can improve your credit score over time. Moreover, a diverse mix of credit including a personal loan can benefit your score as it shows that you can responsibly manage different types of credit.

Myth 2. Personal Loans are a Quick fix for Improving your Credit Score

It is true that personal loans can benefit your credit score over time, but it is by no means a “quick fix”. Improving your credit score requires consistency in responsible credit behaviour. Some ways to do this include making on-time credit card or loan payments, keeping the credit utilisation ratio below 30%, and not applying for too much credit at once.

Myth 3. A High Credit Score guarantees Personal Loan Approval

While a high credit score will make your loan application stronger, it does not guarantee that your loan will be approved. You also have to meet other personal loan eligibility criteria such as age, work experience, and minimum income.

Myth 4. A Higher Income makes up for a Lower Credit Score

A significantly high income may be considered a good indicator of your repayment ability. However, a low CIBIL score can point toward credit irresponsibility in the past, making lenders hesitant to approve the loan amount.

How can Personal Loans Impact Credit Scores Positively?

Provided you manage them wisely, here are some ways personal loans can improve CIBIL score -

  • On-time payments: Making timely loan payments will help you build a positive payment history, the most important factor influencing credit scores.
  • Credit utilisation ratio: Personal loans are instalment loans, meaning they do not contribute to the credit utilisation ratio. Using personal loans to consolidate credit card debt can help decrease this ratio that shows how much credit you are using against the credit amount available to you. A low credit utilisation ratio, ideally below 30%, generally has a positive impact on your credit score.
  • Improved credit mix: Having different types of credit including personal loans can show lenders that you can manage them responsibly.

Factors to Consider when using Personal Loans to Enhance Credit Scores

While personal loans can be useful for credit score enhancement, they need to be managed responsibly to avoid complications down the road. Here are some factors to keep in mind -

  • Borrow only the amount that you can comfortably afford to pay back. Missed payments or defaults will negatively affect your credit score, and can also stay on the credit report for up to 7 years.
  • Try to go for lower interest rates so that you have lower EMIs and minimize the overall cost of borrowing. Look out for any additional fees that could affect the total cost of taking out the loan.
  • Do not neglect other obligations such as credit card bills and any existing loans. Maintain on-time instalments across all open credit accounts.

Tips for maximizing the Benefits of Personal Loans for Credit Score Enhancement

Here are some ways to get the most out of personal loans for credit score enhancement -

  • Keep the loan amount restricted to what you need and do not use the loans for unnecessary expenses that will add to your financial burden. Consider using it to consolidate a high-interest credit card debt, if the personal loan interest rate is lower than the existing credit card debt.
  • Maintain a good payment history as it often has the most impact on your credit score. Set up reminders or auto-pay to avoid missed payments.
  • Do not apply for multiple loans within a short period. Each time a hard inquiry is conducted, your credit score can be temporarily lowered.

Conclusion

Credit score enhancement takes time and consistent financially responsible behaviour. Whether a personal loan will positively or negatively affect your credit score depends entirely on how you manage it. Making on-time payments across all credit accounts and keeping a low credit utilisation ratio will help improve your credit score over time. There may be a temporary, short dip in the credit score as a personal loan application generates a hard inquiry from the lenders.

SMFG India Credit requires a credit score of 750 and above for a personal loan application. Provided you meet other eligibility criteria, you can get attractive interest rates that start at 11.99% per annum*. Apply now for a loan amount of up to INR 25 lakhs* with a 100% online application process.

* Please note that this article is for your knowledge only. Loans are disbursed at the sole discretion of SMFG India Credit. Final approval, loan terms, disbursal process, foreclosure charges and foreclosure process will be subject to SMFG India Credit's policy at the time of loan application. If you wish to know more about our products and services, please contact us

FAQs

Does a personal loan improve your credit score?

A personal loan has the potential to improve your credit score, depending on how you manage the loan as well as your credit habits. Here’s how a personal loan can have a positive impact -

  • On-time payments lead to a positive payment history, a crucial factor affecting credit scores.
  • Adding a personal loan to your credit mix creates a diverse portfolio that can show how well you manage different credit types.
  • Using a personal loan strategically to repay an existing credit card debt, which can bring down your credit utilisation ratio.

Will my credit score increase if I pay off a loan?

If you maintain a timely repayment schedule and practice responsible credit behaviour during the loan tenure, paying off a loan can increase your credit score. Please note that it generally takes 30 to 45 days for credit bureaus like CIBIL to update the paid-off loan on your credit report.

How long will personal loans affect credit score?

Personal loans can affect credit scores for both long-term and short-term. Managing the loan wisely and maintaining timely payments can reflect positively on your credit report for as long as 7 years. On the other hand, applying for a personal loan will lead to a hard inquiry that can lower your credit score, but only temporarily.

What is the minimum CIBIL score for a personal loan?

Different lenders may have different requirements for a minimum CIBIL score. SMFG India Credit requires a CIBIL score of 750 and above for you to be eligible for a personal loan, provided you meet other eligibility criteria.

Does early closure of a loan affect the CIBIL score?

Initially, there might be a minimal negative impact on your CIBIL score as your personal loan is taken out of a diverse credit mix. However, it is only temporary. In general, there will be no significant impact due to an early closure as long as you have been managing the loan responsibly. This includes making timely repayments, keeping credit utilisation to a minimum, and not taking out too many loans at a time.

Read More Read Less

Was this helpful?

Yesyes vote
Nono vote
Sorry about that
How can we improve it:
Submit