Do Personal Loans Affect Your Credit Score?

A personal loan is a handy financial tool you can use to cover planned or unplanned expenses like home renovations, car repairs, a family vacation or almost any other need. If you have plans to apply for a personal loan, you may be wondering what kind of impact it may have on your credit. The answer depends on your personal situation and how you manage your loan, so let’s dig into some of the biggest factors at play.

What is a credit score?

A credit score is a rating that tells lenders and others how responsible you are with credit. There are two types of widely used credit scores: VantageScore® and FICO®. While they are calculated slightly differently, both are based on factors like how many credit accounts you have, how regularly you pay your bills on time and how much debt you have.¹

What is a personal loan?

A personal loan allows you to borrow a lump sum of money upfront and repay it over time in predictable, monthly installments that fit your budget. If you get approved for a personal loan through a lender, bank or credit union, you’ll typically receive the funds via direct deposit or check. Then you’ll make regular monthly payments to repay what you borrowed plus interest over a term of typically one to seven years.²

How can a personal loan help your credit?

Fortunately, a personal loan could help improve your credit score in a few different ways, depending on how you manage your loan. Here are some major factors to keep in mind before you apply:

On-time payments

Your credit score may improve if you make your monthly personal loan payments on time, every time. Payment history is one of the most significant factors in calculating your credit score, and consistently making payments on time demonstrates financial responsibility. This positive behavior is reported to the credit bureaus, helping to build a solid credit profile over time and showing lenders that you can be trusted to meet your obligations.

Diverse credit mix

A personal loan could also diversify your credit mix, which refers to the variety of credit accounts you have, such as credit cards, mortgages and auto loans. Your credit mix accounts for a portion of your credit score, and having different types of credit can be beneficial. By adding a personal loan to your existing credit accounts, you demonstrate your ability to manage various types of credit, which can positively impact your credit score when managed responsibly.

Lower credit utilization

If you use a personal loan to consolidate debt, particularly high-interest debt, you may lower your credit utilization ratio — the amount of credit you use compared to your total available credit — as long as you keep your other accounts open.³ Credit utilization is a key factor in your credit score, so keeping it low is important for maintaining good credit.

How can a personal loan hurt your credit?

While a personal loan may be helpful in many situations, it’s important to note that your credit score may be negatively impacted if the loan is not managed responsibly. Each type of personal loan has its own eligibility requirements, costs and associated risk. As always, it’s important to consider your needs and financial situation before deciding whether a personal loan is the best option for you. Let’s take a closer look at how a personal loan could hurt your credit:

Hard inquiries

When you apply for a personal loan, you consent to a hard inquiry, which is when the lender reviews your credit report to decide whether to approve your loan. Each hard inquiry may temporarily lower your credit score by a few points and stay on your credit report for up to two years.⁴ Too many hard inquiries in a short amount of time may harm your credit score.

Missed payments

On-time payments make up a significant portion of your credit score.⁵ If you miss a loan payment or make a late payment, your credit score could go down. While even one missed payment could hurt your credit score, multiple missed payments may lead to more damage. Remember that a missed loan payment could stay on your credit report for up to seven years.⁶

Increased debt

While a personal loan could provide you with the funds you need to cover an expense, it means going into debt, which could negatively impact your credit score, especially if you already have a lot of debt. It’s a good idea to consider why you’re applying for the loan in the first place to ensure you have the funds to cover your new payments along with your existing debt payments and other financial obligations. Keep in mind that if you’re using your loan to consolidate debt, you may be able to reduce your balances on other accounts and offset this.

How to minimize any negative impact on your credit score

If you’re interested in a personal loan but want to limit any negative effect on your credit, keep these tips in mind.⁷

• Compare your loan options: If you shop around and compare your options, you may be able to find a more affordable interest rate and better terms that could reduce your risk of late payments and default. Don’t be tempted to go with the first lender you come across.
• Check to see if you prequalify before you apply: Many lenders' websites offer the option for you to check to see if you prequalify for a personal loan offer on their website. By prequalifying, you can get an idea of potential loan offers and won’t have to worry about harming your credit score in the process. To check for prequalified offers, all you have to do is fill out a short form with basic personal information and in some cases your desired loan amount.
• Make your payments on time: Make it a priority to make your loan payments on time or even pay off your loan early. You might want to sign up for automatic payments, so you don’t have to keep track of due dates and ensure the money is taken out of your bank account on time. Or you can add a reminder to your calendar or on your phone a few days before the due date, so you don’t forget.
• Repay the loan in full: Stick to your repayment schedule and continue to repay your personal loan until you’ve completely paid it off. If you default on your loan, your credit score will take a significant hit.

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Prequalify before you apply

A personal loan can offer many benefits, including predictable monthly payments and a fixed interest rate. Although you may see an initial decrease in your credit score when you first take out a loan, you could improve your score over time by always making on-time payments and repaying the loan in full. Be sure to check for prequalified offers before you apply to help you make the best decision for your money goals. At OneMain, just checking for offers won’t affect your credit, so you can explore your loan options without sweating a drop in your credit score.

Sources

1, 5, 6 What is a Good Credit Score? Experian
3, 7 How Does a Personal Loan Affect Your Credit Score? Experian
4 How Long Do Hard Inquiries Stay on Your Credit Report? Experian