Is a Loan or Credit Card Better for Your Credit Score?

When deciding whether a loan vs credit card is better for your credit score, it’s essential to understand how each option affects your financial health and credit profile. In Australia, both loans and credit cards can have a significant impact on your credit score, but they do so in different ways.

Loans and credit cards are both forms of credit, but they serve distinct purposes and are managed differently. A loan, whether it’s a personal loan, car loan, or home loan, involves borrowing a lump sum of money that you repay over a fixed term with regular payments.

Credit cards, on the other hand, provide a revolving line of credit that allows you to borrow up to a certain limit and pay it off over time with minimum payments.

Credit Utilisation Ratio is a Major Factor That Affects Your Credit Score

One major factor affecting your credit score is your credit utilisation ratio, which is the amount of credit you are using relative to your total available credit.

Credit cards impact this ratio directly, as they offer a revolving credit limit. High credit card balances or maxing out your credit limit can negatively impact your credit score.

To maintain a healthy credit profile, it’s generally advisable to use less than 30% of your credit limit and to pay off the balance in full each month whenever possible. This practice helps demonstrate to credit reporting agencies that you are managing your credit responsibly and not overextending yourself.

Loans Affect Your Credit Utilisation Ratio Differently

Loans, by contrast, do not typically affect your credit utilisation ratio in the same way. Instead, they impact your credit score based on your payment history and the amount of debt you carry.

Making timely payments on a loan can positively affect your credit score, as it shows that you are capable of managing debt responsibly. Conversely, missed or late payments can harm your credit score and stay on your credit report for years.

One of the benefits of loans is that they provide a structured repayment plan, which can make it easier to budget and stay on top of payments.

Another Factor You Should Consider

Another aspect to consider is the effect of new credit inquiries on your score. When you apply for a credit card, the lender performs a hard inquiry on your credit report, which can temporarily lower your score. Multiple credit inquiries in a short period can be particularly damaging.

Loans also involve hard inquiries, but because they are often for larger amounts and have a fixed term, they may be perceived differently by credit scoring models compared to the frequent, smaller inquiries associated with credit cards.

How to Maintain a Good Credit Score

Managing both credit cards and loans effectively is key to maintaining a good credit score.

Responsible use of a credit card – keeping balances low, making timely payments, and only applying for credit when necessary – can help build a positive credit history. Similarly, managing a loan by making consistent, on-time payments and avoiding excessive debt can also support a strong credit profile.

Ultimately, whether a loan vs credit card is better for your credit score depends on how you manage each type of credit.

For some, using a credit card responsibly can help build a positive credit history by demonstrating consistent, manageable credit use. For others, maintaining a good credit score might hinge more on managing loan payments effectively and keeping debt levels within reasonable limits.

Both types of credit can contribute to a healthy credit profile when used wisely. The key is to balance credit use by avoiding excessive borrowing and ensuring timely payments.

By understanding the impacts of loans vs credit cards on your credit score and managing them appropriately, you can maintain and potentially improve your financial standing. Whether you choose to focus on credit cards, loans, or a combination of both, your approach to managing these financial tools will ultimately determine their impact on your credit score.

If you have any questions, please contact us.