Our goal at Credible Operations, Inc., NMLS Number 1681276, hereafter referred to as “Credible”, is to give you the tools and confidence you need to improve your finances. Although we promote the products of our partner lenders, all opinions are our own.
How a personal loan affects your credit score depends on your particular financial situation. Learn more. (Stock)
If you’re struggling with high-interest credit card debt or need money for an unexpected expense or a large purchase, you might be considering a personal loan. Depending on how you use it, a personal loan can either help or hinder your credit.
This article explains how a personal loan affects your credit score so you can decide if you should apply for one.
If you decide a personal loan is right for you, Credible lets you compare personal loan rates from multiple lenders, all in one place.
How Personal Loans Can Improve Your Credit Score
Take out a personal loan can have a positive effect on your credit score, which can help you get approved for loans and other financial products in the future. Here are some ways a personal loan can improve your credit score:
Build a positive credit history
Lenders look at your credit report to find out if you are paying your bills on time or not, as this can indicate the likelihood of you paying off a new loan. If you take out a personal loan and make your monthly payments in full and on time each month, your credit report will show that and your credit score could improve. Payment history represents 35% of your credit score.
Create a credit mix
A personal loan can add to your credit mix, which can also increase your credit score. Different types of financial products make up your credit mix, which represents 10% of your credit score. A diverse mix of credit cards, loans, and other accounts can boost your credit score. A personal loan is an installment loan, and paying one off in addition to other financial products can help boost your credit score.
Reduce your credit utilization rate
Your credit utilization ratio tells lenders how much revolving credit you are using compared to how much credit you have. If you’re not using any of your available credit, lenders can’t get a handle on how you’re managing your debts. If you max out your available credit, lenders might assume you have too much debt to handle and they might be reluctant to lend you. Most experts agree that it’s best to use 30% or less of your available credit.
A personal loan can help lower your credit utilization rate — since it’s an installment loan, it doesn’t count in this calculation. If you use more than 30% of your available credit on your credit cards, consolidate this debt taking out a personal loan can reduce your credit utilization rate and improve your credit score. Your credit utilization rate falls under the FICO category of “amounts owing” and represents 30% of your credit score.
Credible allows you compare personal loan rates without affecting your credit score.
How Personal Loans Can Hurt Your Credit Score
Although personal loans can improve your credit score in several ways, they can also negatively affect your credit in certain situations.
Too Many Difficult Asks Can Lower Your Credit Score
Using credit wisely is the best way to make it work in your favor. You should only apply for a personal loan when you really need it for something important, such as covering a large expense or consolidating credit card debt.
Serious investigation occurs when a lender accesses your credit report after applying for a loan. Serious claims can stay on your credit report for up to two years. Too many of these requests can cause your credit score to drop, as it indicates that you may be incurring new debt. If you apply for many loans, including personal loans, over a short period of time, lenders may see this as a signal that you are having financial difficulty and apply for loans to make ends meet.
Serious inquiries are different from informal inquiries, which do not affect your credit score. Soft credit checks can occur when you or a potential employer check your credit report, or when you receive a pre-approved offer from a lender.
Increase your debt
Taking out a personal loan could hurt your credit score by adding to the “amounts owed” category of your FICO calculation. Also, if you use a personal loan to pay off credit card debt, but start charging your credit cards again, you will accumulate more debt.
Missed payments can lower your credit score
If you miss just one payment on your personal loan, it can hurt your credit score. In fact, missed or late payments negatively affect your credit score more than any other factor, since payment history accounts for the highest percentage of your credit score (35%).
Before taking out a personal loan, make sure that you are able to repay it and on time each month, and that you will also be able to pay your other bills on time. You can use a personal loan calculator to get an idea of how much a personal loan could cost you each month.
How to apply for a personal loan
Although the exact process varies by lender, here are the steps you’ll typically follow to apply for a Personal loan:
- Check your credit. You are entitled to a free copy of your credit report each year from the three major credit bureaus (Equifax, Experian and TransUnion). This saves you from applying for a loan before you’re ready and possibly having a serious investigation, which could lower your credit score. If you see errors on your credit report, dispute them with the appropriate credit bureau.
- Decide how much to borrow. It depends on how much you need and how much you can afford to repay. Remember that you will also pay interest on the loan and the lender may charge fees that increase the total cost of the loan. It is best to borrow only the exact amount you need.
- Compare lenders. Comparison shop, looking for lenders who can offer you the best terms.
- Get prequalified. Contact the lender of your choice and find out how much you may be eligible for.
- Apply. Once you are prequalified, you can complete a formal loan application. Loan funding times vary by lender, but you can receive your money the same day you apply in some cases.
If you’re ready to apply for a personal loan, Credible lets you compare personal loan rates in minutes.