Effect of a Loan on your Credit Score

Taking out a new loan will affect your credit score but it will automatically reduce it..

Indeed, the American idea of prosperity is that a person should be in debt. If he is in debt, and pays installments, regularly then is worthy of more debt. In America no one trusts a person who owes nothing. This sounds sarcastic but it is absolutely true. Your credit score is lower if you don’t owe money because then you cannot be paying it back and it is the act of paying it back that elevates the credit score.

However, not paying back regularly will ruin your credit score, so when you take out a loan, be sure that you can afford the payments. It’s not the $300,000 debt that matters but your ability to pay it off at a $1,000 a month.

Recently, many have been getting into trouble because their loans on houses, often in the millions of dollars at initially low but adjustable insurance rates, are now impossible to pay for because those rates have increased. To add to this problem, often the value of the houses have decreased, so a person might find himself paying the mortgage on a house originally worth $2 million but which is now only worth $1.3 million.

I use a price in the millions for convenience but the same disaster works at any level. One really doesn’t want to pay for a $200,000 house when it’s only worth $80,000.

With the higher rates of interest you may not even be able to afford the monthly payments in which case the bank will foreclose your mortgage and take your home. Imagine what that event does to your credit score, even though, with the economy as it is, the situation is not entirely your fault.

It is, of course, principally your fault: (a) for taking out such a huge loan in the first place, and (b) for taking out a mortgage with an adjustable rate, presumably fooled by the very low come-on rate that you were offered in the first place. Your credit score will reflect the blame.

So, in summary, taking out a new loan and paying off the installments regularly will improve your credit score.

On the other hand, taking out a new loan and defaulting on even some of the installments will degrade your credit score, and make the next loan much more difficult to obtain.