You might be in the process of buying your dream home, a new sports car or even about to invest in a leisure asset. Well, we all wish we could buy everything we want, but with financial responsibilities, it becomes difficult without considering other means of financing.

There are many factors to consider when taking out a personal loan, and the most important one is knowing how it will affect your credit score. Apart from personal loans, revolving credit is one of the most common forms of credit, and they can both affect your credit score positively or negatively. Managing your credit score is something that you must do regularly. If you want to be approved for any finance, you’ll need to ensure that your credit score allows for it. Life without a favourable credit score can be a hassle, and it’s an unwanted burden on your shoulders.

Know how credit scores work

The first step to keeping up with your credit score is knowing how it works. Your credit profile impacts you in every milestone of your life. For instance, if you want to buy a car, house or even apply for a cell phone contract, you will need to have a strong credit rating. Lessors use your profile to assess how risky of a client are you, and if it is safe to grant you credit.

Your credit profile is created at a credit bureau using your personal information. The most important elements that make up your profile are your credit and payment history, outstanding debt balances, the types of credit you have and, more importantly, how you use credit. Creditors also monitor whether you make your minimum payments every month.

All this information is fed through a personal loan calculator that calculates your overall score. Credit bureaus in South Africa mainly use FICO scores, which normally range between 300 – 850 points. The higher your score, the better your chances of finance.

Let’s break it down:

  • 300- 579: your rating is poor, and the chances of you getting your loan approved are slim.
  • 580- 669: your rating is fair, and you are still considered high risk or otherwise known as a subprime borrower.
  • 670- 739: your rating is good, and you are a relatively stable borrower.
  • 740- 799: your rating is very good, and you are likely to receive a better than average rate.
  • 800- 850: your credit rating is exceptional, and you will get the best rates from lenders.

Understanding personal loans

Personal loans are a form of a credit issued to help you pay for any big purchases you want to make. The loan can go towards funding a small business, buying a house or buying a new car, whichever way you choose to utilise it. Being approved for a loan can be an exciting experience, but you need not forget that it is an obligation that you will be tied to. So, make sure that you understand the terms and conditions of your agreement.

When applying for a loan

When handing in your application to take out a loan for personal reasons, you will trigger an inquiry. Your lender will have to perform a “hard check” on your credit profile. This means that your full report will be pulled to obtain your detailed financial history if you have any. The downside of these inquiries is that they affect your credit rating negatively. A hard check will lower your credit score, and will likely reflect on your report for up to two years.

How a personal loan will affect your payment history

When you take out a personal loan, you will probably opt for a flexible personal loan. This agreement will allow you to pay off the loan in monthly instalments until you pay off your entire debt amount. This factor is entirely dependant on your spending patterns and behaviour. One missed payment can result in your score taking a plunge. So, make sure that you are comfortable with your repayment fee and avoid tainting your credit payment history.

How your total debt owed will be affected

When taking out a personal loan, you are adding on to your entire debt, increasing your overall total. If you have a poor credit score, adding more debt will likely decrease your credit score even further. However, if you have no credit history at all, adding to your debt will help your total amount owed in the long run and give you a better chance of being accepted.

The advantages of getting a personal loan

  • Credit mix: you might be thinking, what are the advantages of taking out a personal loan when I am just adding onto my debt? Well, the first advantage is that it adds to your credit types. At the beginning of the article, we mentioned that one of the most important elements that contribute to your credit score is the type of credit you have. While the type of credit only counts as 10% of your ratio, it is important to have a variety in your credit mix.
  • Payment history: whether you already have an established credit record or are someone who is looking to build one; getting a personal loan will help add to, and establish a payment history. Simply put, you need to create credit to be able to get credit. But always ensure that you make all of your minimum payments on time.

The disadvantages of getting a personal loan

  • Additional debt: this goes without saying. Getting a personal loan will increase your debt. Be a smart borrower and only borrow what you need, and what you will be comfortable repaying. Always take into account your other debts when deciding on getting a loan.
  • Interest fees: lenders charge additional interest fees that cannot be avoided. Late payment may result in you getting additional late fees, and you won’t see any progress in lowering your balance. Avoid this by all costs.

How to improve your bad credit

Before taking the step to improving your credit, you need to know what the factors are that are causing you to have a poor score. So, start by analysing your credit to see where your shortcomings are. Make sure that you pay your bills on time, every month. This also includes your monthly bills such as utility, electricity and phone bills. To help ease that burden of having to remember your bills, set up debit orders to ensure your bills are managed for you.

Try and use less than 50% of your total credit, and maintain a low balance on all of your accounts. This will help you avoid being so far gone that you cannot afford your repayments.

All revolving credit accounts either have a service or an administration fee to keep them open. If you have an account that has been unused for a while now, it’s not wise to forget about it. It is likely that companies are incurring a lot of fees as time passes.

Final thoughts

When getting a personal loan, determine if it will benefit or hurt your credit. Everyone’s credit is different; for example, what works for you may not work for the next person. Be a responsible borrower and only borrow what you need. Don’t forget to maintain a positive credit score and follow the steps to continually improve it.