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Before taking out an emergency loan to cover an unexpected expense, consider how it will affect your credit. As with any other type of loan, taking out an emergency loan will have some effect on your credit score. However, the impact of an emergency loan on your credit score doesn’t have to be a big negative. In fact, if you manage the loan well, it may even help improve your credit score in the long run.
The impact of emergency lending on credit
Emergency loans are typically unsecured personal loans. Like any other loan, taking out an emergency loan requires a rigorous credit check from the lender. This may temporarily lower your credit score. However, taking out an emergency loan can improve your credit score if you repay it on time.
Here’s how an emergency loan can affect your credit score.
Creates an inquiry on your credit report
When you apply for a loan with a lender, the lender will do what is called a hard inquiry on your credit. This means that the lender is requesting your credit report from a credit bureau to understand your credit history and decide whether to lend you money.
Hard queries will lower your credit score in the short term (usually for a few months) and remain on your credit report for two years. Making too many queries at once may give lenders the impression that you’re applying for multiple loans at once and think you won’t be able to repay them in full.
Contribute to a good payment history
If you can make payments on time, getting an emergency loan can help you build a strong payment history and boost your credit score. Payment history accounts for 35 percent of your FICO credit score calculation, making it the most important factor.
Providing a better credit mix
Your credit mix also affects your credit score and accounts for 10 percent of your score. Your credit mix is the different types of accounts you have in your credit portfolio. Having a variety of different credit accounts open, such as credit cards, personal loans, auto loans, and mortgages, can improve your score. If the loan you take out for an emergency is a new type of loan, it can improve your credit mix and increase your credit score.
You may have debts that you cannot repay
If you take out an emergency loan without the funds to repay it, your credit score can be negatively affected. Just as making payments on time leads to a good payment history, making late payments or not making any payments leads to a bad credit history. Credit history is the single largest factor in determining your credit score. Missing payments can cause your credit score to drop significantly, and quickly.
What is the minimum credit score for an emergency loan?
Credit score requirements typically vary by lender and loan type. However, to qualify for an emergency loan, you usually need at least a “fair” credit score (FICO score of 580 to 669). The better your credit score, the better the interest rate on the loan. A good FICO credit score is 670 to 739, and a very good credit score is 740 or above.
While a good credit score is an advantage, it is possible to get an emergency loan even if you have bad credit. Your options will be limited, and interest rates will likely be much higher than for those with good credit. You may think that a payday loan is your only option, but research alternatives to payday loans before you turn to these risky and expensive products.
Make sure you are able to repay any bad credit loans you take out. Do not take out emergency loans that will negatively impact your financial situation as they will likely make your situation worse in the long run.
Other eligibility requirements for emergency loans
While your credit score is important, lenders consider additional factors to determine whether you are likely to repay your loan on time and whether they will grant you the loan. The most common qualification requirements are:
- Adequate income: Lenders want to see if borrowers have enough income to repay their loans each month. Lenders will want to see pay stubs and other documentation to prove your income level.
- Summary of monthly costs and payments: Lenders also take into account your debt-to-income ratio (DTI), which is the ratio of your monthly debt to your monthly income. If you have a high income but high debt load, a lender may not approve your loan.
- Identification: This allows the lender to prove you are who you say you are and verify all your other information.
- Proof of Address: A home address shows your living situation is stable, which is more favorable to lenders.
Conclusion
No matter what the emergency is, an emergency loan will affect your credit. Consider the pros and cons and evaluate your situation, needs, and eligibility requirements to determine if applying for an emergency loan is right for you. If an emergency loan seems unaffordable, consider alternatives like a mortgage-secured line of credit, a loan from friends and family, or a 0 percent APR credit card.
