How Do Installment Loans Affect Your Credit Score?

When the subject is credit score improvement, installment loans come to our mind- and that is because payments are paid back in fixed monthly installments over a period of time. It is vital to have a good credit score to avail yourself of affordable interest rates. No lender can “give the green light” to your application without affordability checks, of which part is a credit score check.

Those who struggle with a less-than-perfect credit score are often advised to use credit builder loans. They are sort of installment loans. When you make payments on time, your lender will report them to credit reference agencies.

Instalment loans may have both positive and negative impacts on your credit score. Here is what impacts you will see on your credit report using these loans:

• Credit inquiries

When a new application is submitted, your lender expects a credit check. Some emergency loans, including payday loans, do not involve a credit check at all – and therefore, they can “cost you an arm and a leg” – but instalment loans are subject to hard credit (it means credit inquiries will show up on your credit file).

Each hard inquiry pulls 5 points. Luckily, the impact of credit inquiries is temporary and disappears after making a couple of payments. Your credit score drops when you apply for a loan as it implies that you are not good at money management.

The impact of credit inquiries can be fixed in a matter of time if you do not often rely on loans. Multiple inquiries will quickly add up the effect, and your credit score will sharply dip. It can be hard to fix that. Your chances of qualifying for a loan will also drop.

• Payment history

Lenders report your payments to credit reference agencies every month. Your payment history accounts for 35% of your credit score. Your credit report will look stellar when you manage to show you made previous payments on time.

Lenders also inform credit bureaus of your missed payments. Not only will missed payments pull your credit points, but they will make it difficult for you to get the nod for a loan down the track. A missed payment is not reported immediately. You will receive a notice from your lender insisting on an instant payment.

You will have a period of 30 days to bounce back, but if your payment is 30 days past due, you cannot stop it happening. Late payment fees will be added to your account increasing the amount of debt.

You should have a backup plan to ensure consistent payments despite financial problems. Talk to your financial department if you have doubts about falling behind on the payment. Informing your lender beforehand can help you avoid late payment charges and credit score damage. They might put you on a new repayment plan.

• Credit mix

A credit mix makes up a 10% proportion of your credit score. Lenders would want to be assured that you can manage all types of debts. Having only a record of revolving credit on your report will call your credibility into question. Lenders might doubt that you will have difficulty sticking to the payment plan. When you have different types of loans, such as credit cards, mortgages and auto loans, your credit score can go up. It will help you qualify for affordable interest rates.

• Reduces your credit utilization ratio

A credit utilization ratio makes up a 30% proportion of your credit score. It is a significant factor that you cannot ignore at all. It is a significant factor that you cannot ignore at all. Despite the settlement of your credit card balance on time, a high credit utilization ratio suggests that you, more often than not, rely on debts to meet your obligations.

Replacing your revolving debt with an installment loan will reduce your credit utilization ratio which in turn results in a boost in your credit points. Adding an installment loan will have a good impact on your credit mix too.

Short-term installment loans are not worthwhile

There are a few lenders that provide short-term installment loans that last for a month. They are emergency loans that you pay down in weekly installments. Those types of debts cannot help you make your credit report stellar.

Because of their small amount, they are not even reported to credit reference agencies. But when you make a default, your credit score will be ruined. Do not trust guaranteed installment loans for bad credit with no credit check. A reputed direct lender cannot offer you an installment loan without a credit check. A soft credit check must be made even if you are taking out a short-term installment loan.

Any lender offering installment loans with a no credit check should be considered loan shark. They must be avoided.

Other ways to help do up your credit file

Apart from installment loans, you can use the following methods to boost your credit rating:

• Increase your available total credit without using it to lower your credit utilization ratio.
• Pay your bills on time. Consistently paying your bills will protect your credit rating. Do not miss the payment of your rent.
• Create an emergency cushion to cover unexpected expenses so you do not have to rely on loans all the time to meet your needs. Too much debt can lower your credit points.
• Use ExperianBoost to report the payments of your utility bills that are not normally reported to credit bureaus.

The final word

Installment loans can help improve your credit score, provided you manage them responsibly. Your payment history is not enough to boost your credit rating. You need to take care of many other factors such as a credit utilization ratio, a credit mix, and a debt-to-income ratio. It may take some time to fix your credit score health because your on-time payments cannot offset previous damage.