Will an emergency loan impact my credit?

May 16, 2023

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Before taking out an emergency loan to meet unexpected expenses, think about the impact it could have on your credit. Taking out an emergency loan, like any other type of loan, will have an impact on your credit rating. However, this is not necessarily a significant negative impact. On the contrary, if the loan is well managed, it may even help improve your credit rating in the long run.

How do emergency loans affect credit rating?

Emergency loans are usually unsecured personal loans. As with any other loan, obtaining an emergency loan requires a thorough credit check by the lender. This may result in a temporary drop in your credit rating. But taking out a loan can also improve your credit rating if you make your payments on time.

Here are all the ways an emergency loan can affect your credit rating.

Establishing a credit report

When you apply for a loan from a lending institution, the lending institution conducts what is known as a thorough credit check. This means that the lending institution requests your credit information from the credit bureaus to understand your credit history and determine whether they want to lend you money.

A thorough credit check lowers your credit rating in the short term-usually for a few months-and usually stays on your credit report for two years. Too many applications at once can make lenders realize that you are applying for several loans at once and they may think you will not be able to pay them all back.

This can contribute to a positive payment history

If you are able to make your payments on time, taking out an emergency loan can improve your credit rating because of your good payment history. Payment history accounts for 35 percent of the FICO credit score calculation and is therefore the most important factor.

Improved credit distribution

The composition of your credit portfolio also has an impact on your credit score to the extent of 10%. Credit mix is the variety of types of accounts you have in your credit portfolio. Having different types of accounts open, such as credit cards, personal loans, auto loans, and mortgages, helps improve your score. If the emergency loan is a new type of loan, it can help improve your credit portfolio and your score.

It can create debt that you are unable to repay

If you take out an emergency loan without having the funds to repay it, your credit score can suffer. Just as on-time payments contribute to a good payment history, late or missed payments contribute to a bad credit history. This can reduce your credit score.

Minimum credit score for an emergency loan.

Creditworthiness requirements generally vary depending on the lending institution and the type of loan. In general, however, you must have at least fair credit (a FICO score between 580 and 669) to qualify for an emergency loan. The higher the credit score, the better the interest rate on the loan. A good FICO score is between 670 and 739, while a very good score is 740 or more.

Although better credit is favorable, it is possible to get an emergency loan with bad credit. Options will be limited and interest rates will likely be much higher than for people with better credit. Make sure you are able to repay a loan with bad credit. Do not decide to take out an emergency loan if it negatively impacts your financial health, because it could make your situation worse in the long run.

Other eligibility requirements

Although your credit rating is important, there are other factors that lenders consider in deciding whether to give you a loan. Lenders consider several factors to determine whether you are able to repay the loan on time. Here are some of the most common eligibility requirements:

Sufficient income: The lending institution wants to make sure you earn enough each month to repay the loan. It wants to see pay stubs or other documents that show your income level.
Overview of monthly expenses and payments: Lenders also look at your debt-to-income ratio. This ratio shows how much you owe each month compared to your monthly income. If your income is high but your debt load is also high, the lender may decide not to approve your loan.
Proof of identity: shows the lender that you are who you say you are and allows them to verify all other information.
Proof of address: a stable address shows that your living situation is stable and makes you more favorable to the lender.

Whatever your emergency situation, an emergency loan will have an impact on your credit. Assess your situation, your needs and your eligibility criteria to determine if an emergency loan is right for you. If an emergency loan seems unmanageable, consider other options, such as a mortgage line of credit, a loan from friends or family, or an interest-free credit card.

Written by

Irene Scott

Insurance

I’ve worked for more than 5 years as a Credit Analyst and more than 4 years as an Internal Auditor for one of the leading global financial institutions. I have been exposed to the credit review process, various banking products, financial security topics, corporate governance, operational risk, and the internal control framework of a complex, multinational organization.