In this business world, would you expect anybody to lend you money without surety? Nobody can afford to lose a lump sum of money to a borrower who can’t pay it back. To be on the safer side, they tend to go for proofs that say the eligibility of loan borrowers. One such factor is your credit score. Your credit score plays a vital role in determining the outcome of your loan application. Let’s examine the direct correlation between credit score and loan approval, the impact of loan applications on your credit, how to secure a personal loan with bad credit, and ways to boost your credit score for improved loan prospects.
Importance of Credit Scores
Did you know? One in five Americans aged between 20 to 29 are not aware of their own credit scores. It is really important for them to come out of this state and start knowing what impact credit scores will have on their loan application. If your credit score is poor, which denotes poor financial behavior. This will affect your chances of loan approvals. On the other hand, some would have started undertaking financial activities on their own. As a result, they would not have a credit score as well. Though this is not as risky as a bad credit score, your loan vendors will be left with no options to verify your eligibility to pay back loans.
To help you with your desired loans, there are considerable options available out there. Out of them, the ideal option is to stay in a healthy credit score range and get approved for loans. This is highly recommended as it involves no risks like high interest rates. On the other hand, there are also vendors that lend online bad credit loans Canada and a few others where you can secure loans but at high-interest rates.
The Direct Impact of Credit Scores on Loan Approval
Your credit score at the time you request the loan will decide your chances of getting approved. According to Experian, one of the major credit bureaus, lenders rely heavily on credit scores to evaluate the risk of lending money. Higher scores indicate lower risk, which directly improves the likelihood of loan approval.
Essentially, the higher your credit score, the better your chances of getting approved for a loan. Lenders view applicants with good credit history and high scores as reliable borrowers who are likely to repay their loans on time.
As credit scores range from 300 to 900, here is the range classification and their value in the world of loans and credits.
- Applicants with credit scores above 760 have an excellent chance of getting approved. Many lenders view this as the optimal credit score range.
- People with credit scores between 640 to 759 are likely to get approved but may not get the best terms.
- Applicants with scores below 640 typically face loan denial or stringent requirements like needing a co-signer.
Each lender may have their own credit score cutoff for loan approval. Checking lender requirements is important. Factors like income, existing debt, and collateral also play a role along with credit scores.
Overall, aiming for the highest possible credit score improves your odds of loan approval and better terms. Paying bills on time, limiting hard inquiries, lowering utilization, and fixing credit report errors can help boost your score.
Credit Score Ranges
There are many credit scoring standards, based on which the credit score range and the value are mapped. But, regardless of the scoring model, the value it shares is relatable. FICO scores, being the most popular credit scoring model, categorize the credit score into 5 different categories. Also, FICO made an analysis to visualize what percentage of people are in each category.
|Credit Score Range||Category||% of Consumers|
The category is directly proportional to their chances of loan approval. A higher score will put you in a better position on the scale of your loan vendors.
How Your Credit Score Affects Your Loan Payments
The predominant impact of low credit scores is loan approval. You might struggle to get approved for the loans you wish for. Though this is the most common impact you know, there are a few more as well. Interest rates might skyrocket based on how low your credit score is. The lower your credit score, the higher your interest rates. Individuals with poor credit pay significantly higher interest rates on credit cards than those with excellent scores. This demonstrates that lower credit scores lead to higher interest rates and consequently greater loan payments.
NerdWallet has listed the average interest rate of each type of loan for all categories of credit score.
|Credit Score||Auto Loan Rate||Mortgage Rate|
|500 or lower||14.45%||6.28%|
The interest rate differential can add up to thousands of dollars over the lifetime of long-term installment loans like mortgages. Your credit score has a direct bearing on your financial well-being.
Higher interest rates mean you pay thousands more for big loans like mortgages and auto loans. Your credit score has a direct bearing on your long-term financial well-being. Even a 1% difference in rates can cost tens of thousands extra in interest charges over the years.
The Impact of Loan Applications on Your Credit Score
While credit scores influence loan decisions and terms, the reverse also holds true.
Here are some of the reasons why and how a loan application can impact your credit score.
- Applying for loans without estimating your payback potential.
- Applying for many loans in a short period of time.
- When you miss out on paying monthly dues.
- Availability of loans in a way that falls outside the credit mix criteria.
- Every hard pull made by the loan vendor will impact your credit score
Out of these possible reasons, a few might not be aware of the hard pull concept. Here is a quick explanation of what it is and how it will affect your credit score. Loan applications can affect your credit score, especially if there are multiple hard inquiries in a short period.
When you apply for a loan, the lender will request the credit bureaus to check your credit report. This hard inquiry results in a small, temporary drop of a few points in your credit score. However, the effect of a single loan application is usually negligible and diminishes over time. Your score typically recovered within a few months.
Understanding Hard and Soft Credit Inquiries
It’s important to understand the difference between types of credit inquiries and their impact. Based on who makes the credit check requests, and for what reasons, the credit inquiries are classified into two categories like hard inquiries and soft inquiries. Here we will understand the difference between these two types of inquiries in a quick comparative table.
|Hard Inquiries||Soft Inquiries|
|Made by the loan vendor||Made by a credit user|
|To check the creditworthiness of the loan borrower||To estimate one’s creditworthiness|
|Has a slight impact on credit score||No serious impacts on credit scores.|
|Too many inquiries will affect your credit history.||You can make as many as possible.|
|Will stay in the report for around 2 years and then fall off gradually.||Will not get recorded in the credit history.|
While hard inquiries cause a small, temporary drop in scores, soft inquiries have no impact. Only hard credit checks count when calculating your score.
How to Improve Your Credit Score for Better Loan Terms
Here are some tips to boost your credit score before applying for a loan:
- Pay bills on time – Payment history has the biggest impact on your scores.
- Lower credit utilization – Keep balances low relative to credit limits.
- Check for errors on your credit report – Dispute and fix mistakes to improve your score.
- Avoid applying for too much credit – Multiple applications in a short span can lower your score.
Also, when rate shopping for loans, applications within a 45-day window count as a single hard inquiry. This prevents your score from being penalized for smart shopping.
- Does applying for multiple loans affect your credit score differently than a single application?
Yes, multiple hard inquiries within a short period can have a greater negative impact on your credit score compared to a single application.
- How much can a loan application impact my credit score?
A single hard inquiry typically only lowers your credit score by a few points. The impact is small and temporary.
- Can I still get a loan with a low credit score and how does it affect the terms?
You can still get approved for loans with lower credit scores but you may face higher interest rates, shorter repayment terms, and lower approved amounts. Poor scores increase the risk for lenders.
The Bottom Line
Your credit scores define your financial behavior. Upon reviewing your credit, loan vendors will decide whether to approve or reject your loan application. To get through this credit check, you must focus on your credit behaviors like prioritizing your loans, on-time payments, and following a proper credit mix. All these factors will put you in the safe credit zone and improve your chances of getting approved for your desired loans and that too at a low-interest rate.