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How does taking a personal loan affect your credit score?

How does taking a personal loan affect your credit score?

Many Aussies use a credit card to pay for their shopping, holidays, and even household and vehicle maintenance. However, credit card companies charge a significantly higher interest rate, making personal loans an attractive alternative for some borrowers. 

But taking on a personal loan is also a financial act; lenders will report it as a credit transaction to credit rating agencies. Typically, both the personal loan size and your ability to make timely repayments can affect your credit score. 

Some lenders may not require a credit check for certain sized loans; such as payday loans that do not exceed $5,000. However, these loans often charge expensive fees.

Does applying for a personal loan affect your credit score?

Applying for a personal loan can affect your credit score in several ways, with the purpose, amount, and term of the loan all playing a part. When a lender requests your permission to access your credit file, it may affect your credit score as it’s marked on your credit history. If you check your credit report, you’ll find that any lender you’ve applied for credit with has reported the application to the credit bureau. This means that your credit score can also be affected if you’re frequently applying for loans, often within a short duration and, in particular, soon after a previous credit application has been rejected. Such incidents can affect your credit score negatively.

On the other hand, a personal loan can help you consolidate your debts or reduce your overall debt burden by helping you pay off a higher-interest loan or credit card. If this is the purpose of your personal loan, applying for it will leave a mark on your credit file. Still, reducing or eliminating debt can help you improve your credit score. 

Taking out a personal loan doesn’t need to be the only solution for a bad credit score. You could, for instance, work on ensuring you earn a steady income and pay your bills or other debt instalments on time. You could also speak to a financial advisor to see if you’ve missed any alternative ways of recovering from excessive debt or bad credit. 

How does taking a secured personal loan affect your credit score?

A secured personal loan can be more attractive than an unsecured loan as you’re likely to get lower interest rates. From a lender’s perspective, a secured loan may present less risk of losing their money. If you default, they can sell the asset the loan is secured against and recover at least some part of the loan amount. 

However, as a borrower, if you’re already struggling to pay off your debts, taking out a secured personal loan could mean risking a bigger default and losing the asset in the process. Borrowers looking to consolidate their debts into a single personal loan could end up facing a significant hit to their credit score if they default on a secured personal loan.

Personal loans also tend to be smaller, purpose-specific debts, for which many lenders do not expect any collateral. For some smaller loans (such as payday loans), lenders may not request a credit check, though you’ll still need to provide proof of a steady, sufficient income to cover the repayments. 

Consider looking for personal loans that allow you to pay more than the scheduled repayment amount and perhaps even giving you a redraw option. Ideally, a short-term unsecured personal loan with no early repayment fee may help you balance loan costs against the potential effect on your credit score. 

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This article was reviewed by Personal Finance Editor Mark Bristow before it was published as part of RateCity's Fact Check process.

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Learn more about personal loans

Does refinancing a personal loan hurt your credit score?

Personal loan refinancing means taking out a new loan with more desirable terms in order to access a more competitive interest rate, longer loan term, better features, or even to consolidate debts.

In some situations, refinancing a personal loan can improve your credit score, while in others, it may have a negative impact. If you refinance multiple loans by consolidating these into one loan, it could improve your credit score as you’ll have only one outstanding debt liability. Your credit may also improve if you consistently pay the instalments on time.

However, applying to refinance with multiple lenders could negatively affect your credit if your applications are rejected. Also, if you delay or default the repayment, your credit score reduces.

What is a bad credit personal loan?

A bad credit personal loan is a personal loan designed for somebody with a bad credit history. This type of personal loan has higher interest rates than regular personal loans as well as higher fees.

How much can you borrow with a bad credit personal loan?

Borrowers who take out bad credit personal loans don’t just pay higher interest rates than on regular personal loans, they also get loaned less money. Each lender has its own policies and loan limits, but you’ll find it hard to get approved for a bad credit personal loan above $50,000.

What is a personal loan?

A personal loan sits somewhere between a home loan and a credit card loan. Unlike with a credit card, you need to sign a formal contract to access a personal loan. However, the process is easier and faster than taking out a mortgage.

Loan sizes typically range from several hundred dollars to tens of thousands of dollars, while loan terms usually run from one to five years. Personal loans are generally used to consolidate debts, pay emergency bills or fund one-off expenses like holidays.

What is a credit rating/score?

Your credit rating or credit score is a number that summarises how credit-worthy you are based on your credit history.

The lower your score, the more likely you are to be denied a loan or forced to pay a higher interest rate.

Are there emergency loans with no credit checks?

While many personal loans require a credit check as part of the application process, some personal loans and payday loans have no credit checks, which may appeal to some borrowers with a bad credit score.

Keep in mind that even if a loan is available with no credit check, the lender will likely want to confirm that you can afford the repayments on your current income.

Can I get guaranteed approval for a bad credit personal loan?

Few, if any, lenders would be willing to give guaranteed approval for a bad credit personal loan. Borrowers with bad credit histories can have more complicated financial circumstances than other borrowers, so lenders will want time to study your application. 

It’s all about risk. When someone applies for a personal loan, the lender evaluates how likely that borrower would be to repay the money. Lenders are more willing to give personal loans to borrowers with good credit than bad credit because there’s a higher likelihood that the personal loan will be repaid. 

So a borrower with good credit is more likely to have a loan approved and to be approved faster, while a borrower with bad credit is less likely to have a loan approved and, if they are approved, may be approved slower.

How can I get a $3000 loan approved?

Responsible lenders don’t have guaranteed approval for personal loans and medium amount loans, as the lender will want to check that you can afford the loan repayments on your current income without ending up in financial hardship.

Having a good credit score can increase the likelihood of your personal loan application being approved. Bad credit borrowers who opt for a medium amount loan with no credit checks may need to prove they can afford the repayments on their current income. Centrelink payments may not count, so you should check with the lender prior to making an application.

Can I get a bad credit personal loan with a guarantor?

Some lenders will consider personal loan applications from a borrower with bad credit if the borrower has a family member with good credit willing to guarantee the loan (a guarantor).

If the borrower fails to pay back their personal loan, it will be their guarantor’s responsibility to cover the repayments.

Is a personal loan a variable or fixed-rate loan?

Depending on the personal loan lender, you may be able to choose between a fixed and a variable interest rate. But, there are a few distinct differences between the two, so it’s important to weigh up the pros and cons before deciding on what’s right for you.

A fixed interest rate loan gets you the convenience of knowing exactly how much you need to repay each fortnight or month. On the other hand, you generally won’t be able to make lump sum or advanced payments to close your personal loan early - or at least not without a penalty.

With a variable interest rate personal loan, you may be able to get a longer loan repayment term, with the option of paying off the loan early. You typically won’t need to pay any additional charges for an early full repayment either. The potential disadvantage with an interest rate that can change is that your repayment is not entirely predictable, as it can fluctuate with the market. However, you’ll likely have more options as more lenders offer a variable interest rate personal loan.

Can I merge my personal loan with my home loan?

Yes, you can refinance your home loan and, in the process, merge or consolidate your personal loan and home loan. By doing so, you can lower the number of debts you have, and you may also reduce the total interest you have to pay.

However, you should consult a financial advisor or a mortgage broker to confirm that you are decreasing your total outstanding debt, including interest payments. The repayment term for a home loan can be much longer than that for a personal loan, and by merging the two, you could be repaying a higher amount over the full term.

What causes bad credit history?

Bad credit history is caused by filing for bankruptcy, defaulting on your debts, falling behind on your repayments and having loan applications rejected. Lenders are wary of borrowers who demonstrate this sort of behaviour because it suggests they might struggle to repay future loans.

Borrowers with bad credit may find it more difficult to be approved for a loan, or they may get higher interest rates when they do get approved.

Which lenders offer bad credit personal loans?

Several dozen lenders offer bad credit personal loans in Australia. These are generally smaller lenders that aren’t household names.

What is an unsecured bad credit personal loan?

A bad credit personal loan is ‘unsecured’ when the borrower doesn’t offer up an asset, such as a car or jewellery, as collateral or security. Lenders generally charge higher interest rates on unsecured loans than secured loans.