How closing a personal loan impacts your credit score
What's the story
Closing a personal loan in India can have a temporary impact on your credit score, but it is not as bad as it seems. The effect is usually small and short-lived, and your score will recover over time if you manage your finances responsibly. This article explains how the closure of a personal loan can affect different aspects of your credit profile.
Credit composition
The impact on credit mix
Your credit mix, which includes secured and unsecured loans, can be affected by closing a personal loan. If you had a combination of one secured (home loan) and one unsecured loan (personal loan), closing the latter would leave you with only the home loan. This change in credit mix from both secured and unsecured to just secured could have a minor negative effect on your score.
Loan duration
Short-term loans and credit history
If you had never availed of credit before and took a short-term personal loan, its closure could stall your credit history's progress. This is because the personal loan was the only credit instrument you had used. However, if you made timely repayments, it would have helped build a positive payment history during that period.
Age factor
Credit aging and its effect on score
Credit aging, or the length of time you've had credit accounts, is another factor that affects your score. If the closed personal loan was your longest-held credit instrument, its closure could reduce credit aging and slightly lower your score. However, like other factors, this effect is temporary and will improve over time with responsible financial behavior.
DTI impact
Personal loan closure and debt-to-income ratio
The closure of personal loans can improve your debt-to-income (DTI) ratio, which is the percentage of your income that goes toward paying off loans. A lower DTI ratio makes you more eligible for new loans. For instance, if your monthly salary is ₹1 lakh and you pay ₹35,000 toward EMIs for three loans, your DTI ratio would be 35%. Closing a loan with an EMI of ₹15,000 would bring this down to 20%, making you eligible for more credit.