How Taking Out Multiple Loans Can Affect Your Credit
How Taking Out Multiple Loans Can Affect Your Credit
How you manage your loans is one of the biggest determining factors in your credit score. Every financial advice column you read tells you to always pay your loans on time and you’ll be alright - but there is a lot more than timely repayment to responsible loan management. An often overlooked part of taking on debt is how many loans and credit lines you try to obtain. Sure, servicing a loan or credit card every month is a great way to build a solid credit report, but what about those who apply for multiple debts? Today we explore how taking on several loans can affect your credit.
A Sign Of Financial Instability
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Applying for a single loan with an express purpose (ie - buying a new car or starting a business) is a great way to establish credit, especially when you are young. The problem comes in applying for too many loans and consumer credit cards in a short period of time. This sort of behavior tells lenders that you are a credit risk, because you are not financially stable enough to survive on the loans and credit you’ve already been granted.
This is one of the reasons why student financial blog FinAid advises that students “avoid opening new accounts that you do not need.” Better is to save your available loans and credit lines for the times when you really need them, such as applying for student loans. If every time you want to make a new big purchase you try to open up a new credit line, your report will make you appear both financially unstable and risky, which could jeopardize your ability to get important loans later in life.
Potential For Spending
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Applying for a loan when you already have one is difficult enough, but if you have multiple lines of credit open, a new loan is even riskier. The old saying “everything in moderation applies heres - one or two responsibly managed credit cards is considered helpful to your credit, however having a wallet full of open cards sends off red flags in the mind of any new lender. The reason for this is because you have a greater potential to engage in risky spending, which makes it less likely that you will have the money available to repay your new loan. A person with a credit card to every store in the local mall could, on a whim, decide to rack up an incredible amount of debt, leaving the new lender to fight for your repayment attention against all the other credit lenders he or she just borrowed from.
Carrying A Balance Can Improve Your Credit
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Just like any other business, lending is practiced to produce a profit, though it isn’t always obvious to the inexperienced borrower where this profit comes from. The answer is interest - the rate you are charged for carrying a balance on your loans or credit cards is a return paid to the lender for providing you with the loan. Personal finance consultant Suze Orman explains that carrying a low balance on several varied debts while reliably making on-time payments can actually improve your credit score as opposed to completely paying off your entire principle every month. When a lender sees that you make on-time payments but still carry a light balance, it means that you pay interest, which is good news for them.
Credit Card And Loan Applications
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Believe it or not, you don’t even need to be approved for a loan or credit card for it to affect your credit. Merely applying for a lot of credit in a short period of time can negatively affect your score. Personal finance blog DoughRoller explains that when you apply for credit, you authorize the lender to perform a hard pull, or manual check of your credit report. Of course, not all hard pulls affect your score in the same way, as some loans (such as auto loans and mortgages) are considered less risky than others. However, DoughRoller makes clear that “applying for multiple [credit card] accounts is viewed as a credit risk, [and] it will negatively impact your credit score.”
Repayment Behavior
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Most borrowers understand that making late payments on your loans (or missing them entirely) is not good for your credit score, but few realize that paying certain loans off early can also tarnish your report. This is commonly seen in the world of student loans, since borrowers in their new careers are often anxious to get these paid off quickly. As explained above, lenders make their money from the interest paid on loans, so when a student comes into a substantial income boost and pays off a ten-year term in half the time, he actually costs the bank or lending institute money.
Debt advice blog MyLoansConsolidated explains that paying off your student loans early can lower your score an entire 10 - 15 points, depending on the lender and the speed of repayment. Interestingly, a student loan that takes too long to repay can also negatively affect your score. MyLoansConsolidated notes that any loan taking more than ten years to repay will be marked as “too long to pay off a debt” and can sully your score.
Auto Loans And Mortgages
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While it’s true that taking out multiple loans or credit lines can lower your score, there are two kinds of loans that can help it - auto loans and mortgages. These are seen as far less risky than a personal bank loan or a credit card, because if the borrower defaults on the loan, the lender has the right to claim a valuable asset (the house or car) to settle the debt. This is what is known as a secured loan, because the principal amount is secured in the asset. Conversely, if a borrower defaults on an unsecured personal loan or line of credit, the lender has no recourse other than to pursue them in court, and that is far from a guarantee of payment.
Additional Resources: For more information on financial topics such as car refinancing, click here.
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