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.
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.
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.
Fortunately, there are strategies you can use to limit the negative effect of an installment loan on your credit including:
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.