Have you ever wondered how personal installment loans affect your credit scores? It appears you may have plenty of company.
Like many financial topics, the best answer is “it depends on a number of different factors.” Each situation is unique.
Opening installment loans can help or hurt your credit score, depending on what other items appear on your consumer report, how you utilize the new funding, along with the amount of money you have tucked away in emergency savings.
Like any other form of borrowing, when managed responsibly, new installment loans can stabilize your finances, improve your rating, and position you to qualify for better rates and terms.
When Installment Loans Help Credit Scores
Opening new installment loans can help credits scores when doing so expands the diversity of trade lines on your consumer report, or when you use the money to retire more costly revolving debt.
Request a personal loan with monthly installment payments if these two points pertain to you.
Diversity of Account Types
Opening a new installment loan can improve your credit score by adding to the diversity of your borrowing experience. The algorithms make predictions that are more confident when they see a diverse mixture of account types. It gives them more data to work with.
The most frequently used algorithms operate in the same fashion. You might feel more confident when loaning money to a friend if you could observe his behavior at work, with family, with friends, and while at church instead of just one venue.
Many consumers start by opening a credit card, which is a revolving account. Other account types work differently and may improve your credit mix – which makes up about 10% of your score. Opening different types of installment loans can expand your diversity.
Opening a new personal installment loan to consolidate revolving debt can lower your utilization ratio, which may increase your credit score – temporarily. Your revolving credit ratio makes up 30% of your rating.
Consolidating revolving debt using a personal installment loan has several benefits. You have fewer accounts to pay each month, you may lower your interest rate, and your revolving debt utilization ratio improves, which helps your credit score – temporarily.
The approach boosts your credit score provided you do not run up new balances on your existing revolving accounts!
Credit scores do not consider the utilization ratio of the installment loan itself. This variable correlates with the age of the account and does not predict future delinquencies.
When Installment Loans Lower Credit Scores
Installment loans can be two-edged swords. Consumers can find that they may lower credit scores when they open too many accounts too quickly.
On the other extreme, paying off a loan early is a good thing in general. However, many consumers shoot themselves in the foot by failing to leave an adequate financial cushion.
Too Many Accounts
Opening too many installment loan accounts too quickly may hurt your credit score, and your ability to qualify for a mortgage. Excess in any endeavor leads to problems, and this example is no different.
The amount of newly opened accounts comprises another 10% of your rating. The algorithms tend to subtract points when they see too much new account activity. It shows a hunger for borrowing and is an early warning indicator that a consumer may get into trouble.
Having too many installment loan accounts also increases the odds of delinquency, inflates your total debt amount, and spikes your debt to income ratios. The more accounts you have to pay, the greater your chances of falling behind on multiple accounts. The amount of total debt can suppress risk scores while mortgage lenders will also compare your fixed monthly debt repayment schedule to your monthly income.
Paying Off Early
Paying off installment loans early does little to boost your credit score, but can come back to haunt a consumer who fails to leave an adequate financial cushion. The equations do not reward bonus points for paying off early. The consumer report simply reflects that the outstanding amount we repaid according to terms. Call the effect neutral at best.
Paying off installment loans early may hurt the credit score of consumers unlucky enough to experience a trial during the process. We all will experience setbacks in life. Consumers who leave themselves a cushion can weather the storms more readily.
The problem is that the next payment is due in full the next month, even if you are way ahead of schedule. If you have no emergency fund when the layoff hits, or somebody becomes sick, or the primary breadwinner becomes disabled without disability insurance, you may begin missing payments. Payment history comprises 35% of ratings.
The solution to this dilemma is building an emergency fund of liquid assets that cover at least six months of living expenses. Once you have this fund set aside, aggressively paying down your installment loan debt can affect your credit score positively, even if a trial comes your way during the process.
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