Importance of Credit Score for Personal Loan Approval

28 Jan 2021

What is a Credit Score?

A credit score is a three-digit numerical value ranging from 300 - 800 based on your credit history which evaluates your ability to repay a loan or debt. It is calculated from a credit report normally created by one of the three main credit bureaus – Equifax, Experian, and TransUnion. The most common credit-scoring company is FICO. Your credit score factors in past repayment history and how many accounts you have open, but never personal information such as race, nationality, or marital status. Your credit score can be broken down into 5 categories. 

  • 300-579: Poor
  • 580-669: Fair
  • 670-739: Good
  • 740-799: Very good
  • 800-850: Excellent

What Appears On a Credit Report?

  • Past debts and how you paid them off - this includes car loans, student loans, credit cards, etc
  • Any bills owed to an agency and how you paid them off - medical and utility bills 
  • Public record information - failure to pay taxes or bankruptcies linked to you
  • Credit inquiries - the number of times your creditworthiness was inquired and the result of each inquiry

What Exactly is Considered for your Credit Score?

  • Payment history of past debts
  • Amount of your current outstanding debt - includes all credit cards and loans 
  • Credit history and management - if you maintain a low credit card balance and tend to pay your bills on time then that will positively affect your credit score
  • How often you take out loans or credit cards - if you’ve applied numerous times for loans and credit cards, that can negatively affect your credit score
  • Type of credit in use - credit card, retail accounts, installment loans, finance company accounts, mortgages, etc

Why is it Important?

All banks and lenders will first check your credit score eligibility before considering your personal loan application. The lender needs to be sure that you are a reliable client. The lower your score, the less likely they are to grant approval. The average credit score is 725. A score lower than this can still have access to loans but you will face higher interest rates and fewer options. 

How Can You Improve Your Credit Score?

Review your Credit Reports

  • Understand what factors are working against you so you know what to fix
  • Access your credit report from each of the three major credit bureaus: Equifax, Experian, and Transunion. 
  • Also, check for possible errors that may be bringing down your score and make an appeal to have them fixed

Manage Payments

  • Avoid late payments on loans, bills, and credit cards at all costs 
  • Create a filing system or set due-date alerts to organize your payments

30% Rule

  • Credit utilization plays a big role in your credit score, utilizing a small percentage of your credit limit affects your credit score positively 
  • A good thumb rule is to use only 30% of your credit limit
  • Using a smaller portion of credit makes it easier to pay off as well

Credit-limit increase

  • If your credit limit feels too low and it is difficult to implement the 30% rule then request a limit increase
  • You will need to update your annual household income 
  • If the request is approved, your credit utilization will directly improve 

Limit Credit Card Requests and “Hard” Inquiries

  • Soft credit inquiries such as checking your own credit report or checks done by financial institutions you already do business with don’t affect your credit score
  • Hard credit inquiries occur when you apply for a new credit card, loan, or mortgage and these can negatively affect your score
  • Avoid frequent applications to avoid hard inquiries as much as possible 

Keep Old Accounts Open

  • Even if you have cards that you don’t use, don’t close those accounts
  • By closing accounts you lose your available credit and increase your utilization ratio which would negatively impact your credit score

Bottom Line

Your credit score plays a big role in your ability to take out a loan or credit card. Your credit score factors in all aspects of your credit history to gauge how reliable of a borrower you would be. If a lender feels that your score is not satisfactory, they can reject your application or drastically increase your interest rate and fees. Due to this, it is crucial to improve your score through the methods listed above to prevent such consequences. With an excellent credit score, you’re on your way to cashing in the ideal personal loan for your financial aspirations.