Most of us don’t like the idea of taking debt unless needed. However, the vicious circle of credit wants us to first borrow money in order to build a positive credit history that would, in return, help us take a loan at considerable rate of interest in case of financial emergencies. Whether one has to lend money loan due to an emergency, to fulfil certain life goal or just to build credit, people tend to pay the loan amount early when they have extra cash in order to stay away from deb. But is it recommended? And how will it affect your credit score? Let’s find out! But, before we understand the effect of early loan repayment, let’s understand how loans affect our credit score.
Impact of Loans on Your Credit Score
Surprisingly, taking a loan is a step ahead towards creating a positive credit score, given that you pay the debt amount on time. Here’s how it affect your credit score.
If you already have a credit bill, then opening a new loan account will add diversity to your existing credit, which will enhance of your credit score
Duration of Credit History
Another thing that installment loans help you is to manage your credit over a long period of time. If you have a long history of great credit, then it will not only increase your credit score, thus making loan process easier for you.
Raise Credit Score with Timely Payments
Since, on time payments play the biggest role when it comes to increasing credit score, timely loan payments will not only improve your credit score but will make you an attractive borrower for future.
So, Should One Go For Early Loan Repayment?
Well, experts suggest that having an open loan/debt account is beneficial for your credit score rather than a closed one, which is what your installment loan becomes once it is paid off. So, if you have multiple debts, then you might consider closing one earlier. But in case of single loan, then you might consider it paying as per the schedule. Also, one must remember that paying off loans early will not have any positive impact of your credit score. However, depending upon your credit history, closing your loan account is not recommended in the following cases:
Limited Credit History
According to Experian, one of the major credit bureaus in India, open and active credit account enhances your score. So, in case you have limited or only open loan account, then it is not advisable to close it early. Yes, it will help you save money in interest but will not help in your credit score.
Establish Credit History
In case you have an established credit history, then with too much debt, the lender may see you as a risk. It is important to maintain the debt-to-income ratio. This is basically the percentage of your gross monthly income applied towards debt. This means that the gross income should be able to afford the debt taken.
Instead of paying off the loan, you can pay down the balance. One of the major factors affecting the credit score is the percentage of the available credit compared to the limit. Therefore, if you have taken a new loan or having an outstanding credit card bill, then paying off your personal loan can help lower the ratio.
Hence concludes that if you are paying off the loan early just to enhance your credit score, then don’t go ahead. Instead, you can invest that money in various schemes like mutual funds or fixed deposits or just save it for financial emergencies. Whether you pay the loan amount early or as scheduled, one thing that every borrower should keep in mind is to always pay the due bill on time.