Managing a personal loan can positively and negatively affect your credit score. Simply taking out a loan won’t necessarily hurt your credit, but it could temporarily lower your score and make it harder to get more credit until you pay it off.
On the bright side, making timely payments on a personal loan can improve your credit score over time. To ensure you’re getting the best loan terms possible, compare all your options and do research before signing on the dotted line. Responsible borrowing and prompt repayment can lead to a healthy credit score.
How a Personal Loan Can Affect Your Credit Score
Taking out a personal loan comes with responsibilities. Neglecting these responsibilities can damage your credit score, which may take time to recover. Here’s how a personal loan can impact your credit:
- Credit inquiries: When you apply for a loan, lenders will perform a “hard inquiry” on your credit, which can temporarily lower your credit score. However, if you shop around for multiple loan offers within a short time frame (14–45 days), credit scoring systems may group them into a single event.
- Increased debt: Adding a personal loan to your debt burden can initially lower your credit score. But if you use the loan for debt consolidation, your score may recover once other accounts are paid off.
- Managing payments: A new loan means an additional monthly payment. Budgeting challenges or missed payments can result in late fees, harm your payment history, and hurt your credit score.
To maintain or improve your credit score, ensure that you pay your loan responsibly. Compare loan offers, prequalify when possible, and set up autopay to avoid missing payments.
How Can Applying for a Personal Loan Help Your Credit Score
Taking out a personal loan and managing it responsibly can help boost your credit score in various ways.
- Lowering your credit utilization rate: If you use a personal loan to consolidate high-interest credit card debt, your credit score may improve because your overall credit utilization rate decreases. This rate makes up about 30% of your FICO score, and reducing it can positively impact your score.
- Building a positive payment history: Payment history has the greatest influence on your credit score, making up 35% of your FICO® score. Paying your loan on time contributes to a solid payment history, which in turn helps improve your credit score.
- Diversifying your credit mix: Lenders prefer borrowers with a blend of credit accounts, including both revolving credit (like credit cards) and installment loans. If you currently only have credit cards, adding a personal loan can enhance your credit mix and contribute to a better credit score. Credit mix accounts for 10% of your FICO.
By taking out a personal loan and managing it wisely, you can strengthen your credit score and improve your overall financial health.
What Can I Use a Personal Loan For?
A personal loan provides funds for various purposes, offering flexibility to cover expenses and invest in your needs. Common uses for personal loans include settling tax debts, financing home improvements, or dealing with unexpected medical emergencies.
The versatility of personal loans makes them a practical solution for addressing financial challenges and pursuing personal goals.
Frequently Asked Questions
Can a personal loan improve my credit score?
Yes, a personal loan can improve your credit score if you make timely payments and manage the loan responsibly. This demonstrates your ability to handle credit, which positively impacts your credit history.
Does a personal loan hurt my credit initially?
Applying for a personal loan may cause a slight, temporary dip in your credit score due to the hard inquiry on your credit report. However, this effect is generally short-lived, and your score can bounce back with responsible loan management.
How does a personal loan affect my credit utilization ratio?
A personal loan can lower your credit utilization ratio, especially if you use it to consolidate credit card debt. This can positively impact your credit score since a lower utilization ratio signals responsible credit usage.
Will paying off a personal loan early improve my credit score?
Paying off a personal loan early may not significantly improve your credit score, as the positive impact on your score comes from a history of on-time payments. However, paying off a loan early can save you money on interest.
Can a personal loan help build my credit history?
Yes, a personal loan can help build your credit history if you don’t have a diverse mix of credit accounts or are new to credit. Managing a personal loan responsibly demonstrates your ability to handle credit, which strengthens your credit history.
What happens to my credit score when I finish paying off my loan?
Your credit score may experience a slight dip when you finish paying off your loan, as it closes an active account on your credit report. However, the positive payment history from the loan remains and continues to benefit your credit score.
How long does a personal loan stay on my credit report?
A personal loan typically stays on your credit report for up to seven years after it’s paid off or closed. A positive repayment history can continue to benefit your credit score during this time.
