Understanding the Impact of Loans on Your Credit Score: Strategies for Smart Borrowing

If you want to keep yourself in a good financial position but want to take out credit including loans you’ll need to understand the relationship between loans and your credit score. Your credit score can be the difference between getting the best borrowing terms or having to pay extremely high-interest rates. If your credit score is really low, it can make it hard to borrow at all.

Responsible borrowing is all about only borrowing what you can afford and shopping around to get the best deals. Most kinds of borrowing will cost you, so we advise you to keep these costs to a minimum.

Strategies For Smart Borrowing

Here are some things we suggest you do if you want to take out loans but want to protect your credit score and borrow smartly.

1. Keep your use of credit low

Keep your use of credit low Your credit score is influenced by the relationship between your credit balances and limits. When you take on a new loan, this increases your overall debt and affects the ratio. This is why you need to try to keep the amount of available credit you’re using below 30%. If you “max out” on the amount of credit you have available, this can cut your credit score, making it much tougher to borrow more or get low interest rates, particularly if you have bad credit.

2. Have a diverse credit mix

When lenders make decisions about whether to give you credit, they’re likely to look at the diversity of your credit mix. If you have a diverse credit mix, this means you are using a range of credit products like loans, mortgages plus credit. If you’ve got a mix of credit lines and are managing them well, this might make it easier for you to get finance.

3. Maintain a good and long payment history

We recommend that you make your repayments on time if you want to maintain a good credit score. Any late payments and defaults can have a big impact on your credit rating and make it plummet. Think about keeping old credit accounts open even if you have paid off the balance as this enables you to show lenders that you have a long credit history. You need to maintain a mix of both old and new credit accounts to demonstrate a stable financial history.

4. How to borrow smartly

There are lots of things you can do if you want to borrow smartly so you can avoid high-interest rates, being turned by lenders, or finding yourself in more debt than you can deal with.

5. Shop around to get the best rates

Compare interest rates from a range of lenders including banks, credit unions, and online lenders to get the most favorable terms. Online comparison tools let you evaluate offers but don’t impact your credit score.

6. Only borrow for what you need

You should also avoid borrowing borrowing more than you need to. Think carefully about your financial needs as borrowing more than necessary can cause unnecessary spending and debt while raising your credit utilization ratio. Create a detailed budget so you can work out exactly how much you need to borrow.

7. Understand the terms and conditions of the agreement

Lots of people have been caught out after borrowing without reading the terms and conditions carefully. Look at the terms of your borrowing carefully and closely at details like interest rates, repayment periods, and other fees. You should make yourself aware of hidden charges and penalties for early repayment to make sure you understand what the borrowing will cost you.

8. Maintain an emergency fund

If this is possible, create an emergency fund so you can cover unexpected expenses without having to borrow. If you rely on finance to cover every unwanted financial surprise, you could create a cycle of debt.

9. Take a look at your credit report

You also need to check your credit report for inaccuracies as these could be reducing your credit score. If you do find something on your credit report that shouldn’t be there, we recommend that you get in touch with the lender or the referencing company to get it removed.

10. Don’t forget about the impact of credit inquiries

Every time you apply for a loan or another form of credit, an inquiry will be recorded and included in your report further down the line. If lots of inquiries are made in a short period, lenders can see this as a sign of financial distress and make them think twice about offering credit to you.

11. Use soft search options

Some credit applications only involve soft searches. These searches don’t have an impact on your credit rating. If you’re worried about your credit score, only make applications that involve soft searches.

12. Compare secured and unsecured loans

Secured loans are loans that are backed by collateral. You can use your home, car, or other assets as collateral. These loans normally have lower interest rates due to the collateral involved as it means there is less risk for the lender.

13. Prioritise high-interest debt

Try to pay off any high-interest debt first as this can save you money in the long run and have a great impact on your credit utilization ratio as well.

14. Build a positive credit history

Managing your credit responsibly over a long period can help you build a more positive credit rating. Make all your payments on time, don’t max out your credit cards, and don’t take out more credit than you can afford to pay back.

15. Get financial advice if you need it

Don’t be afraid to seek out financial advice from a specialist if you feel it could help you. An experienced financial advisor who knows the market inside out can provide you with bespoke advice that’s tailored to your specific needs.

16. Review and adjust your plan

What’s relevant one month mightn’t be so effective the next. This is why you should review your financial goals now and then and ensure your current plan is still a good match for them. Changing your strategy when you need to will make sure it still meets your requirements.

17. Save for future goals

Try to save cash so you can meet your future goals without relying on borrowing. Having access to savings can help you reduce your reliance on credit so you’re not affected so much if lenders do turn you down.

Conclusion

Loans can have a bad impact on your credit score, but they can also have a positive influence if you make your repayments on time. We would recommend that you build up your savings and create an emergency fund if you can. This will help you to create more financial freedom for yourself and reduce your reliance on credit.