AECB Credit scores are 3-digit numbers ranging between 300 and 900 in the UAE that indicates your creditworthiness. Technically, your credit score represents how likely you are to default on the repayment of your debt in the next 12 months – a high credit score means less likelihood of repayment default.
For this reason, smart borrowers pay attention to what impacts their credit score and how. This helps them take the necessary steps to maintain a healthy credit score. Everything from opening credit accounts to repaying a loan instalment impacts your credit score.
This article will cover how personal loans affect your credit score. Let’s begin with covering how a credit score is computed and what affects it.
There are a few basic factors that broadly affect credit score computation in the UAE as well as the rest of the world. These factors can include payment history, outstanding debt, length of credit history, credit portfolio, and credit enquiries. Certain weightage is assigned to all these factors based on their level of impact on credit score calculations.
The following is an overview of the weightage assigned to each factor:
Repayment History: 35%
Amount of Outstanding Debt: 30%
Length of Credit History: 15%
Credit Portfolio Diversity: 10%
Credit Enquiries: 10%
Any credit tool that impacts one or more of the above-mentioned factors ends up affecting the credit scores as well. The effect these credit tools have can be both positive and negative in nature. Let’s see if personal loans impact any of these factors and how this impact affects your credit score.
Will Taking Out a Personal Loan Impacts Credit Scores?
Getting a personal loan will affect all five factors in one way or another. Sending an application for the loan will trigger a hard credit enquiry from the lender. If approved, your credit portfolio will now have an additional type of credit tool which will introduce diversity. Adding a new credit tool to the mix will shorten the total length of credit history. Once the loan amount is disbursed, your outstanding debt will increase. Finally, once you start repaying the loan, the repayment history will be impacted.
It is safe to say that obtaining a personal loan affects credit scores in one way or other.
How Do Personal Loans Affect Credit Scores?
Depending on the situation at hand, a personal loan can affect credit scores negatively as well as positively. Personal loans affect credit score primarily via credit enquires, by increasing debt, through repayments, and by rearranging the credit portfolio.
We will examine both scenarios in detail to pinpoint the conditions that make an impact on your score, examining the ones having negative and positive impacts separately.
How can Personal Loans Affect Credit Scores Negatively?
Let’s first cover the factors related to personal loans that may lead to a negative impact on credit scores –
Hard Credit Enquiries
Lenders run a hard credit enquiry on receiving an application for a loan or a credit card – the same applies to the case of personal loans. Hard enquiries reduce the credit score by a few points. While one enquiry will not make a noticeable difference, multiple ones can make the impact substantial. If you have sent one too many applications for getting a personal loan, your credit score will certainly take a dip.
Increment in Outstanding Debt
Taking on a new loan will increase the total outstanding debt amount you have. This particular factor will have the greatest impact of all on your credit score since outstanding debts hold the greatest weightage in credit score calculations.
At the same time, it is essential to remember that this is only a short-term impact. Your score will start improving the moment you start repaying your debt.
Delay in Repayment
Not repaying your loan on time may lead to drastic reductions in your credit score. Repayment habits get 35% weightage in credit score computations, as explained above. Timely repayment of your personal loan, thus, becomes crucial to maintain a healthy credit score.
Even one defaulted instalment stays on your credit history record for over 10 years. Afterwards, it can take a substantial amount of time to rebuild your credit after defaulted loan instalment payment.
How can Personal Loans Affect Credit Scores Positively?
Now that we have discussed the negative impacts on credit scores, let’s put together a few ways in which personal loans affect credit scores positively:
Improves Credit Portfolio Diversity
Having a good mix of different types of credit accounts is ideal to see some improvement in your credit score. Getting a personal loan can introduce the required diversity to your credit portfolio, especially if you have only had a credit card so far.
A personal loan is a type of instalment credit while credit cards belong to the category of revolving credit. Getting a personal loan can help you improve your credit score since credit diversification contributes up to 10% to credit score computation.
One of the most popular and highly recommended uses of personal loans is debt consolidation. Personal loans let the borrowers consolidate their ongoing debt from different credit cards or loan products into one and pay it off at a lower interest rate.
Debt consolidation not only keeps your outstanding debt amount to its current level but also helps in freeing up the credit line on your credit cards. This lowers your credit utilisation ratio, which improves your credit score considerably.
How to Minimise the Negative Impact?
Turing negative impacts of personal loans on credit scores into positive ones is a simple matter of making smart choices and adopting good credit habits. Let’s discuss a few things you can do to minimise the negative impact of getting a personal loan on your credit score:
Only borrow what you can repay easily in monthly instalments so that payment defaults stay out of the picture
Try to take out a personal loan only when you need to consolidate debts. If the requirement of the hour can only be satisfied by taking a personal loan, make sure to compare your options properly before finalising a product.
Evaluate the eligibility requirements well in advance and submit only one application after thorough research. Multiple applications will lower your credit score even before you get the loan.
Avoid applying for other loans and credit cards after getting your personal loan. Give your finances some breathing space and pay off one loan completely before taking on another.
Use an online personal loan calculator to find out the ideal loan amount and tenure you should get at the available interest rate to draw instalments that can be repaid comfortably.
Credit Score Required to Get a Personal Loan in UAE
Most lenders require the borrowers to at least have a 580 credit score which falls into the “low” category as per the differentiation suggested by AECB. However, most lenders offer personal loans as per their risk appetite. This is why even borrowers with a slightly lower credit score can get a personal loan in the UAE.
Keep in mind that your current score will be a key deciding factor for your personal loan terms. Having a low credit score may lead to unfavourable personal loan terms such as lower loan amounts, higher interest rates, shorter loan repayment tenure, and so on. Make sure that you negotiate with the lender as much as the situation allows you to get the best possible deal.
You may also choose to get a secured personal loan if your chosen lender is reluctant to offer you an unsecured loan. The borrower, in this case, would be required to put down an asset as collateral in case of secured loans.
This lowers the risk of payment defaults for the lenders as they can use the collateral to recover the loan amount in case of consecutive defaults. Secured personal loans are easier to get for individuals with low credit scores.
Personal loan affects credit scores in one way or another. Your own actions and choices as a borrower can easily tilt the scale towards the negative or the positive side. As a rule, choose personal loans to consolidate debts and pay them off at a lower interest rate.
If you have an urgent, one-time substantial expense to handle, research thoroughly before taking on a personal loan to finance your requirements. Never default your monthly instalment payments and send in a loan application only when you are sure about clearing the eligibility criteria.
You can always connect to our in-house experts to get guidance about taking on personal loans. Financial experts at Policybazaar UAE can help you select the most suitable personal loan product. Once you have decided, you can apply for a personal loan on policybazaar.ae, our website. Getting a loan is easy and exciting with Policybazaar UAE as your financial partner.
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