Getting a personal loan typically requires a credit check, so it’s important to know what credit score you need to obtain a loan. Credit scores reflect your credit history as documented in credit reports, portraying your proficiency and responsibility in managing debt.
Lenders use these scores to gauge the likelihood of repayment, with higher scores indicating a lower risk of default. Consequently, lending money to individuals with low credit scores is perceived as riskier than to those with higher scores.
Typically, lenders reserve their most favorable loan terms, including lower fees and interest rates, for borrowers boasting high credit scores. Conversely, borrowers with lower scores may face higher charges, aiming to offset the increased risk of potential loan default.
In some cases, individuals with extremely low credit scores may find it challenging to secure credit altogether.
What Credit Score Do You Need for a Personal Loan?
Lenders establish their individual minimum credit scores for personal loans. Typically, a credit score of 670 and above qualifies you for the most favorable interest rates and terms on a personal loan. Some lenders may extend personal loans to individuals with lower scores, but often with less advantageous terms. If your credit score falls short, there are strategies available to enhance it.
How Personal Loans Affect Your Credit Score
A personal loan can impact your credit score in both positive and negative ways. Depending on how you manage the loan, potential positive effects may involve:
• Establishing Positive Payment History
Timely payments on your personal loan, reported by your lender to the credit bureaus, have the potential to enhance the most crucial aspect of your credit score.
• Reduced Credit Utilization
Personal loans, being installment loans, do not factor into your credit utilization ratio. However, using a personal loan to pay down some of your credit card balances may lead to an enhancement in your credit score.
• Diversification in Credit Types
Introducing an installment loan, such as a personal loan, alongside revolving credit (like credit cards), can modestly boost your credit score. Conversely, mishandling a personal loan can have adverse effects on your credit.
Initially, simply applying for the loan can prompt a hard inquiry on your credit report, causing a minor decrease in your credit score. More significantly, failure to make timely payments can result in a substantial reduction in your credit score.
What to Do to Qualify For a Personal Loan
Meeting a lender’s minimum credit score requirement doesn’t guarantee loan approval. However, lenders evaluate a variety of criteria during the application process.
Additionally, lenders vary in considering alternative data like education and profession or focusing on credit report, history, income, and debts. Each lender has its own set of considerations beyond just the credit score.
Lenders typically assess the following factors when reviewing a personal loan application:
• Credit Score
While many lenders rely on the FICO credit scoring model, some opt for the VantageScore. Lenders take a comprehensive approach, evaluating various data points, possibly using either FICO or VantageScore, to determine approval. In addition, the specific scoring model used can vary among lenders.
• Credit History
Creditors prefer to observe an extended credit background when evaluating a loan request. While a lender might specify a necessity for at least two or three years of credit history, a longer history generally proves more favorable.
Typically, the presence of numerous accounts over your credit timeline indicates to the lender your consistent commitment to timely payments. Individuals with various credit cards, a mortgage, or an auto loan, all showcasing punctual payments, stand a higher chance of meeting the qualification criteria.
• Debt-to-Income Ratio
Lenders look for applicants whose income comfortably covers their existing monthly financial commitments, in addition to any new loan payments. They often analyze your debt-to-income ratio to assess whether taking on another loan would strain your financial situation.
• Cash Flow
The debt-to-income ratio, by itself, doesn’t consider essential expenses such as fuel, groceries, and rent. Therefore, certain lenders examine bank account transactions to gauge the surplus funds borrowers retain after meeting other financial obligations.
Lenders are referred to as having “free cash flow,” and a higher amount of it enhances a lender’s confidence in approving your application.
How to Improve Your Credit Score
Improving your credit before applying for a loan enhances your chances of qualifying for a personal loan with a favorable interest rate. Although your credit score won’t transform from poor to good overnight, the following suggestions can contribute to improvement:.
• Make Payments On Time
Payments for credit cards and loans that extend beyond the 30-day mark can lead to a credit score reduction of up to 100 points.
To prevent this, contemplate establishing automatic payments or utilizing due date reminders to avoid missing payments on existing debts. If the payment schedule conflicts with your budget, consider requesting your creditors to adjust the due date.
• Review Errors on your Credit
Examine your credit reports from all three major credit bureaus—Equifax, Experian, and TransUnion—to identify potential errors. These errors include inaccurate account balances or unfamiliar accounts that might be impacting your score negatively.
Challenge any discrepancies through online, mail, or phone dispute methods. Obtain complimentary weekly credit reports at AnnualCreditReport.com.
• Decrease your Credit Utilization
Maintain your credit utilization ratio below 30%, which represents the percentage of your available revolving credit that you’ve utilized.
If the ratio exceeds this threshold, focus on paying down balances on your credit cards and other credit lines. Requesting a credit limit increase is another strategy that can effectively lower your credit utilization.
A higher credit score enhances the likelihood of securing a personal loan with favorable terms. Therefore, before applying, check your credit score and explore ways to improve it for better chances and terms.