Your credit score is a three-digit number that shows how creditworthy you are as a borrower. A high score can open the doors to loan approvals as well as favorable rates and terms. If you’d like to take out an installment loan, you may wonder how it will impact your credit. Keep reading to find out.
What is an installment loan?
First and foremost, let’s go over how an installment loan works. Put simply, it’s a type of credit that offers a lump sum of money upfront. You pay it back in fixed payments or installments, typically every month over a set repayment term.
If an installment loan is secured, you’ll need to back it to collateral or a valuable asset you own, like a house or a car. Some of the most common types of installment loans include mortgages, personal loans, car loans, and student loans.
How an installment loan can hurt your credit
When you apply for an installment loan, the lender will likely pull your credit report to determine whether they’d like to approve you. This will lead to a hard inquiry, which can temporarily drop your credit score by a few points. Also, if you miss even one monthly payment on your loan, your credit score will take a hit. Since payment history accounts for a large percentage of your score, it’s essential that you make your payments on time, every time.
In addition, the added debt from an installment loan will impacts the “amounts owed” category of your credit score. While owing money doesn’t automatically mean you’re a risky borrower, a high balance on your credit account can have a negative affect on your credit as well.
Ways to minimize the negative impact of an installment loan
Fortunately, there are strategies you can use to limit the negative effect of an installment loan on your credit including:
- Prequalify: Many lenders allow you to prequalify and check your loan offers without any impact to your credit. If you prequalify and find out which installment loan is ideal for your unique situation, you can avoid unnecessary hard inquiries.
- Make all payments on time: If you make timely payments on your installment loan, you can improve your credit score. You’ll be able to position yourself as an attractive borrower and qualify for great rates and terms in the future.
- Pay off the loan in full: Continue to make every payment until you’ve completely paid off your personal loan. Repaying your loan will lower your debt and give you some peace of mind.
Even though an installment loan can potentially damage your credit score, it’s a valuable financial tool. As long as you’re strategic about how you apply for it and make your payments, it can help you meet a variety of short-term and long-term financial goals.