Throughout the UK, many consumers use personal loans to cover financial needs. It is estimated that one in four consumers have a loan, with an average balance of £10,000 and a repayment term of four years. The reason behind the popularity of loans is due in part to the predictability of both the cost of borrowing and the repayment term. Loans come with a fixed interest rate and a known repayment time frame, making it easier to budget for this type of financing than a credit card. In recent years, several lenders have also made it easier to get a loan through online and non-traditional platforms, putting some power back in the hands of consumers in need of financing.

Although loans come with unique benefits compared to other credit accounts, there are several aspects of getting a loan of which borrowers need to be aware. Many people overlook the fact that getting a loan has an impact on credit scores, which, if not managed correctly, can make it difficult to get access to additional or different financing in the future. Here are a few ways loans impact credit scores among borrowers.

Impact of Loan Applications

Anytime a new finance account is applied for, the lender extending credit to a borrower performs what’s known as a hard credit check. This credit check allows a lender to scan an individual’s financial history, including types of accounts, payments due both now and in the past, and the frequency of loan or other credit applications. Because there are so many different lenders offering loans both online and in-person, borrowers may be inclined to apply for several different loans at once to ensure they receive the best financing terms. Unfortunately, each application submitted to a lender results in a hard credit check, which ultimately lowers one’s credit score.

According to a finance expert with Money Pug, a site used to compare the best loans, there is no longer a need to submit multiple applications to various lenders. Instead, potential borrowers can use a comparison site to see what loans are available, with specific loan amounts, interest rates, fees, and repayment terms. Instead of applying multiple times, loans can be reviewed without the need for a hard credit check. This small step keeps the negative impact on credit scores muted for savvy borrowers.

Loan Repayment and Credit Scores

In addition to the immediate impact on credit loan applications have, borrowers also need to be aware of the long-term implications of loan repayment. Each monthly payment that is made to the lender for a loan is reported to the credit reference agencies. The details of each loan payment are then used to calculate one’s credit score. If payments are missed or submitted later than when they are due, this can have a negative impact on credit. Late or missed payments remain on a credit report for several years, and this indicates to future lenders that a borrower may not be a good candidate for other credit accounts or financing.

Access to Future Credit

Taking out a loan can be helpful in covering financial needs that exceed what may be available in savings. However, because loans are reporting to the credit reference agencies, a borrower’s ability to get access to new financing for a different reason may be limited initially. Even when loan payments are made on time and as agreed, obtaining credit for a large financial need such as a mortgage for a home purchase may become a challenge. Mortgage lenders want to feel confident that a borrower is financially prepared for a large monthly payment. Having a loan payment on one’s credit report is not likely to remove all possibilities for getting approved for a mortgage, but it may cost the borrower more in the end. Lenders can increase the rate charged for a new loan if there are other debt obligations owed, as listed on one’s credit report.

Loans can be a smart way to finance needs that arise without much warning, but it is crucial for borrowers to recognise the impact a loan has on credit. Taking small steps like comparing loan providers without submitting multiple applications helps tremendously in keeping the negative effects of a loan to a minimum.

Claire James