Do loans affect your credit score?

Do loan applications affect your credit score?

When you apply for a loan, lenders will run a credit check. This leaves a mark on your credit file called a "hard search". Each hard search can lower your score by a few points temporarily.

If you apply for several loans in a short time, multiple hard searches appear on your file. Lenders might worry you're heavily reliant on credit or taking on too much debt. This can hurt your chances of approval and lower your score further. However, the impact is usually small, and your score recovers within a few months.

Most comparison sites let you check your eligibility with a "soft search" first. This doesn't affect your score and helps you see which loans you're likely to get before you apply properly.

How can a loan help boost your credit score?

When you manage a loan responsibly, it can have a positive impact on your credit score.

Making regular, on-time payments shows lenders you're trustworthy

Each month you pay as agreed adds positive information to your credit file. Over time, this builds a strong payment history that helps to improve your score.

Loans add variety to your credit mix

Having different types of credit - like a loan, credit card, and phone contract - can help your score. It proves you can handle various financial responsibilities.

Paying off a loan demonstrates you can manage debt 

This completed agreement stays on your file as proof of your reliability.

Even if you've had credit problems in the past, a loan can help rebuild your score. By consistently making payments, you create new positive history that gradually outweighs old mistakes.

How can a loan hurt your credit score?

Loans can damage your credit score in several ways:

Missed or late payments

Your payment history makes up a large part of your credit score. When you miss a payment, lenders report it to credit reference agencies. A missed payment can stay on your report for six years and hurt your score. The more payments you miss, the worse the impact.

Defaulting 

If you stop paying altogether, the lender registers a default on your credit report. This stays there for six years and makes it very hard to get credit. In serious cases, you might face a County Court Judgment (CCJ), which damages your score even more.

Taking on more debt 

When you add a new loan to your existing debts, future lenders will see you have more financial commitments. They might worry you'll struggle to manage everything and could default. This can make them less likely to approve you for credit, even if your score looks okay.

How to limit a loan's impact on your score

There are some ways you can reduce the negative effects from a loan on your credit score:

Only apply for loans you're likely to get approved for

Read up on the lenders eligibility requirements and use soft search tools to check your chances of acceptance first.

Space out your applications

If one lender rejects you, wait a few months before trying again. This prevents multiple hard searches clustering on your file.

Borrow only what you can afford to repay

Check your budget carefully before committing to a loan. Missing payments damages your score far more than not borrowing at all.

Set up a Direct Debit

This can ensure you never miss a payment (providing you have available funds in your bank account). Automating your repayments removes the risk of forgetting.

Make overpayments when possible

Paying more than your agreed monthly payment reduces your debt faster. Before you do this, make sure there are no penalties from your lender to do so, as some may enforce early repayment charges.

What to consider before taking out a loan

Before you borrow, think about how the loan will affect your credit score:

• Can you make every payment on time? Even one missed payment damages your score for six years. Be realistic about whether you can commit to regular repayments.
• How much existing debt do you have? Adding a new loan increases your total debt. If you already owe a lot of money, lenders might see you as overextended and risky, which can lower your score.
• How many credit applications have you made recently? Multiple applications in a short time hurt your score. If you've applied for other credit recently, consider waiting.
• What's your current credit score? If your score is already low, you might be better off improving it first by paying down existing debts before taking out another loan.
• Will you need more credit soon? If you're planning to apply for a mortgage or car finance in the next few months, a new loan could affect your chances.

Taking out a loan is a big decision that affects your credit score for years. Borrow wisely, pay consistently, and your score can improve. But miss payments or overstretch yourself, and the damage can last a long time. Think carefully before you commit.