Reaching the end of your loan term and making your final repayment can be a satisfying feat. But will paying off your personal loan give your credit score a boost, or could it have the opposite effect?
It all comes down to your personal credit file and the overall active credit products you hold.
Australia’s major credit reporting bureaus, Experian and Equifax, don’t disclose exactly how they calculate your credit score, but generally consider the following factors:
- The number of credit accounts you have – Whether it’s multiple accounts of the same type of credit, or a range of different types of credit.
- Your credit mix – This could include one or any number of instalment loans such as personal loans, car loans, and home loans, or revolving debt such as credit cards.
- Used vs available credit – This refers to revolving debt where you may only have a portion of your credit limit in use at any one time.
- The length of your credit history – This refers to the age of your active credit accounts.
- Your payment history – This can include repayments, late payments, defaults, and bankruptcies.
The determining factor that may hold the most weight when paying off a personal loan is the length of your credit history. Credit providers generally like to see that you have a long track record of responsibly paying down your credit accounts.
If your personal loan is your only form of credit, or your longest held account, your credit score could initially take a hit when you finish paying it off. This is because it will no longer be listed as an active account and will thus shorten the length of your credit history.
Similarly, if your personal loan is the only kind of instalment loan you hold, then your credit mix could be impacted and in turn affect your score.
However, according to Experian, a potential credit score reduction as a result of paying off a personal loan will likely only be temporary. Plus, the benefits of paying off your loan, such as minimising your debt and reducing your debt-to-income ratio, tend to outweigh any initial credit score dip you may face.
Does applying for a personal loan hurt your credit score?
If you’re on the other end of the borrowing process, you may be wondering how applying for a personal loan might affect your credit score.
While simply applying for a personal loan shouldn’t hurt your credit score, it’s important to note that every application for credit will be recorded on your file as a hard enquiry when the lender runs a credit check.
If you apply for multiple personal loans at the same time, or in quick succession after being knocked back, your credit score could potentially take a hit.
Lenders may also view this as a sign of credit stress, which could result in a reduced chance of approval.
Doing your due diligence before applying for a personal loan could help you protect your credit score and avoid having your application rejected.
What credit score do you need for personal loan?
Generally, credit providers reserve their most competitive credit products for excellent credit borrowers. But that doesn’t mean you won’t be approved for a personal loan if your score is less than excellent.
Borrowers with good to excellent credit scores will typically find it easier to get approved for a personal loan compared to borrowers with fair, below average, and poor credit scores.
Similarly, those with higher ranking credit scores will typically also be offered lower interest rates and better deals than those with scores in the lower bands.
While there isn’t a specific score that will guarantee your approval for a personal loan, the higher your credit score, the more desirable you may be as a customer to lenders.
If you have a below average credit score and time is on your side, you might like to consider working towards boosting your score before applying for a personal loan.
