The traditional mindset is that one should stay away from debts. We have all heard of the horrific consequences of lifestyle inflation. We were also often told to save up for things we wanted and for emergency scenarios.
However, it’s well-meaning advice, you have to take a risk when you are trying to do big, life-defining purchases.Take buying a house for example. This is a huge investment, especially if you are a young professional in your early 20s or 30s.
Conventional wisdom says you save up for the house before buying it. However, this strategy has opportunity costs. You will pass up affordable price rates just because you have not saved enough money when the property was offered. For you to avoid this and be able to get the best deals, you will need to apply for a loan.
And when a financial institution such as a bank or licensed money lenders in Singapore considers your loan application, one thing they will do for sure is to do a background check. They will look into your credit history and your credit score. If you’re a first-time borrower or didn’t care about credit score before, read up to better understand what it is and how loans affect it.
What is a credit score?
A credit score determines your creditworthiness. If your score is high, it means financial institutions believe you’re a good borrower who pays their loans. On the other hand, a low score means they don’t trust that you’ll pay on time or sufficiently. And since lending is a business, lenders look at your credit score to see if the risk of you defaulting on payments is low.
In Singapore, you can request for a credit report from the Credit Bureau of Singapore (CBS) for a fee. This is useful when you are trying to effectively evaluate your capacity to avail of a loan. It will also give you information on the likelihood of approval of your loan application. Most banks use your credit score to determine how much they are willing to lend you.
Also, while credit score is a major factor, there are other factors lenders consider before approving your loan. They will check your employment status, source/s of incom, and your current financial situation. Also, some loans require collateral, so they will check if you have real properties like land or condominium units.
Lastly, aside from lenders, a good credit score also matters for some employers. After all, your reputation will give them an idea regarding your character. Your ability to comply with obligations, especially financial ones, will show how responsible you are. If you have a dream job or a dream company, taking care of your credit score means protecting your chances of getting hired for the position you are eyeing.
Your credit score acts as your financial score card. In effect, it is a consolidation of your past financial behavior. It’s why lenders will still look for your credit score even after completing a background check on you. It gives the potential lender a clear picture of the risk they will take on if they approve your loan application. You would not want to scare them away by what they see in your credit report. Let us examine the advantages and disadvantages of applying for a loan and how it can affect your credit score.
How loan applications, payments, and failure to pay affect your credit score
Since your credit score is affected by your payment history and past behavior as a borrower, any instances of late payment or default will negatively affect it regardless of reason. You cannot explain to a prospective lender that you were not able to pay on time because you suddenly lost your job. You cannot reason that your loan payment was affected because you were hospitalized or your house needed some repairs.
Be mindful of how your loan affects your credit score. Here are some points to note:
Pay on time
Your loan agreement clearly states when payments should be made. These deadlines are not negotiable. Set aside funds for your loan payments days in advance of the deadline. If you cannot set aside the full amount, try setting aside half of the amount due. This way, you can identify any problems in advance and you will still have time to think of a solution. Take note that if you receive a late payment notification from your lender, this will affect your credit score.
Multiple loans are hard to track
Applying for multiple loans at the same time or within a short period of time will also have a negative impact on your credit score. Every time you apply for a loan, the potential lender will ask for your credit file with the goal of assessing the risk of lending you money. This is also known as a hard inquiry and it shows up on your credit report. It implies that your financial behavior has again left you no other option but to borrow money, which a red flag for potential lenders.
Another problem with having multiple loans is that you can fail to track all of them. One good way to prevent this is to put a reminder on your phone as soon as you sign the loan agreement,. This will alert you of deadlines you need to meet. This will also help you avoid interest and penalty payments.
However, prevention is better than cure. If you don’t have multiple loans but considering it, limit it to two. Loan agreements often have different payment terms and late charge fees. It would be confusing if you have multiple loans with monthly payments and have to remember a lot of data just for one month.
Lastly, if you have car loans on top of your personal loans, make sure you have a foolproof tracking system. Defaulting on any of these obligations will have an effect on your future financial goalsm and your car could get repossessed.
Do not forget your credit cards
Aside from loans, credit cards are also considered as debt. Late payments of credit card obligations will also result in a drop in your credit score. It operates on the same principle that late payments are indicative of your sense of responsibility and your financial capacity. Why would a lender risk their business by lending you more if you cannot handle what is currently on your plate?
How to mitigate risks and protect your credit score
Plan ahead and strategically before availing of a loan. While loans may seem like the perfect solution to your current financial concerns, they will affect your financial standing. Lack of preparation often leads to default. Also, the stress of making sure your credit score survives unforeseen events and emergencies can also take a toll on your health.
Give yourself options. Build an emergency fund before signing up for new financial obligations. Avail of insurance products to ensure you have coverage in case you get sick or you get hospitalized.
Lastly, minimize risks by preparing contingency plans and increasing your income streams. If you have existing debt, whether from loans or credit cards, prioritize paying these debts whenever you have extra money.
Remember, your financial actions today will affect your credit score, which in turn will have an impact on your future. Take it as a form of self-care.
If you find yourself struggling to maintain a good credit score, make sure to get in touch with your lender or your bank. You can ask them if they offer loan restructuring options or if they have products that can help you increase your credit score.
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