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Many Aussies use a credit card to pay for their groceries, vacations and even household and vehicle maintenance. However, credit card companies charge a significantly higher interest rate, making personal loans an attractive alternative for some borrowers.

But taking on a private loan is also a financial act; Lenders report it as a loan transaction to rating agencies. Typically, both the amount of personal credit and your ability to make timely repayments can affect your credit score.

Some lenders may not require a credit check for certain size loans; such as payday loans that do not exceed $5,000. However, these loans often incur expensive fees.

Does applying for a personal loan affect your credit score?

Applying for a personal loan can affect you credit-worthiness in several respects, with the purpose, amount and term of the loan playing a role. If a lender asks you for permission to access your credit file, it may affect your credit score as it is recorded in your credit history. If you check your credit report, you’ll find that every lender you’ve applied for a loan from has reported the application to the credit bureau. This means that your creditworthiness can also be affected if you apply for credit frequently, often within a short period of time and especially shortly after a previous credit application has been rejected. Such incidents can negatively affect your credit rating.

On the other hand, a personal loan can help you consolidate your debt or reduce your overall debt burden by helping you pay off a loan or credit card with higher interest rates. If that is the purpose of your personal loan, applying will leave a mark on your credit file. Still, reducing or eliminating debt can help you improve your credit score.

Getting a personal loan doesn’t have to be the only solution to bad credit. For example, you could work to ensure that you earn a steady income and pay your bills or other debt payments on time. You could also speak to a financial advisor to see if you’ve missed alternative ways to recover from excessive debt or bad credit.

How Does Taking Out a Secured Personal Loan Affect Your Credit Score?

A secured personal loan can be more attractive than an unsecured loan because you are likely to get lower interest rates. From a lender’s perspective, a secured loan may pose less of a risk of losing one’s money. If you default, you can sell the asset against which the loan is secured and recover at least part of the loan amount.

However, if you, the borrower, are already struggling to pay off your debt, taking out a secured personal loan could mean you risk a major default and lose your assets in the process. Borrowers looking to consolidate their debt into a single personal loan could end up taking a significant hit to their credit rating if they default on a secured personal loan.

Personal loans tend to be smaller, earmarked debts, too, and many lenders don’t expect collateral for them. For some smaller loans (such as payday loans), lenders may not require a credit check, although you will still be required to show proof of regular income sufficient to cover repayments.

Consider looking for personal loans that allow you to pay more than the planned repayment amount and may even give you an option to renew. Ideally, a short-term unsecured personal loan with no prepayment penalty will help you balance the cost of borrowing against the potential impact on your credit score.