Do Personal Loans Hurt Your Credit Score?

Need a personal loan but worried about it affecting your credit score and the overall status of your credit? Maybe you’re also concerned that taking the loan out now will affect your ability to get another loan – or a mortgage – down the road. While a personal loan will affect your credit, the nature of its impact can vary.

Let’s look at how personal loans can influence your credit in both positive and negative ways.

With a personal loan, you’re borrowing a lump sum of money all at once, then making regular monthly payments until you’ve paid it all back, plus interest. This is in contrast to a revolving loan where you can continuously borrow against a line of credit, only paying interest on what you’ve borrowed and paying it off as you go, as you would with a credit card.

When you apply for and receive a personal loan, your lender will report it to the major credit bureaus: Experian™, TransUnion^® and Equifax^®. This is no different than any other type of financing.

As you pay back the loan in installments per your repayment terms, your progress will be reported to the credit bureaus. Your credit score could increase if you make on-time monthly payments, but your score would likely suffer if you miss payments.

In the upcoming sections, let’s review some circumstances in connection with a personal loan that could end up damaging your credit.

Missed Or Late Payments

As already mentioned, your credit score is apt to drop if you don’t keep up with your loan payments.

Your payment history shows how often you’re making on-time payments on your debt, and this history is the most important factor in determining your FICO® Score. If you miss a payment on any of your credit accounts, even just once, your credit score can drop – potentially a lot – and the delinquent account will be noted on your credit report.

Hard Inquiries

Whenever you apply for a new credit account of any kind, the lender will pull your credit report, resulting in a hard inquiry that causes a small, temporary drop in your credit score.

When applying for an installment loan, such as a personal loan, borrowers commonly shop around and check with multiple lenders in hopes of finding the best deal. Borrowers often get prequalified with multiple lenders, who all run a soft credit check. A soft credit check won’t affect your credit score, but multiple soft credit pulls within a span of a few weeks could have the same effect as a single hard inquiry.

Paying Off The Loan

A personal loan could potentially hurt your credit, at least temporarily, when you finish paying it off.

When you close a personal loan account, your credit score can sometimes take a small hit. This isn’t because you’ve done anything wrong, but it’s because you’re closing an account that was having a positive effect on your score.

A well-handled closed account can have a positive impact on your score as well, but it won’t have as much of an effect as an open account. Your credit score may also suffer a slight dip because you’re making your credit mix less diverse when you close an account.

Personal loans and other forms of installment debt can also benefit your credit score in various ways. Let’s take a look at them next.

Building And Improving Your Credit Score

When used correctly, a personal loan can help you build or improve your credit score. A solid history of full, on-time payments will account for roughly 35% of your credit score. By simply staying on top of your monthly payments, you’re paving the way for a good credit history. It’s possible to use a personal loan to build credit, but it isn’t always wise.

Installment debt can go a long way toward making – or breaking – your score. With an installment debt, you make payments every month over a period of months or years. This helps increase the length of your credit history, which lenders can later evaluate.

Diversifying Your Credit Mix

Your credit mix is how many types of accounts you have. These may include credit cards, personal loans, mortgage loans and the like. Lenders prefer to see that you can handle different types of credit – specifically, installment and revolving credit.

A personal loan on your credit report can give you a more diverse credit mix. If the only credit accounts you have open are credit cards, adding a personal loan can give your credit score a boost.

Lowering Your Credit Utilization

A personal loan can also help raise your credit score in an indirect but significant way. If you have a lot of credit card debt, you probably have a pretty high utilization rate. Since credit utilization is such a big factor in determining your credit score, using a personal loan to pay off your credit card debt can significantly increase your score. That’s because installment debt, such as a personal loan, doesn’t factor into your credit utilization ratio.

Whether you should use a personal loan for credit card debt will depend on your financial situation.

Consolidating Your Debt

Using a personal loan for debt consolidation can likewise give your credit score a lift.

Suppose you have several credit cards with a high interest rate and balances so large that you’re having trouble making more than the minimum payments each month. In this situation, it might make sense to seek a personal loan in order to combine and pay off all your credit card debt, trading in multiple high-interest payments for a single monthly payment with a lower interest rate. (A personal loan tends to come with a lower rate than a credit card.)

Keep in mind, however, that this tactic only works if you’re committed to reducing your credit card debt in the long term. If you use a personal loan to pay off your credit cards but later max them out again, you aren’t addressing the root of the issue.

Here’s an at-a-glance view of how various personal loan events can affect your credit score.

A hard inquiry can reduce your credit score one to five points, even if you’re not approved for the loan in the end. If you miss a payment on your loan, even just once, your score could drop up to 180 points.

Even after you’ve paid off your personal loan, the account will stay on your credit report for up to 10 years. Debt accounts in good standing when they’re paid off can give you a positive credit boost as long as they stay there.

Charged-off or delinquent debt – accounts you were late on or accounts sent to collections – can stay on your credit report for 7 years after the account was first reported as delinquent. However, the negative effects of the late or missed payments will likely begin to fade before the account gets removed from your credit report.

Getting a personal loan can affect your credit in numerous ways, and it’s important to weigh those effects when deciding whether to pursue this loan option. If you have poor credit already and wouldn’t qualify for a good interest rate, a personal loan could do more harm than good. If your credit is in good or great standing, a personal loan may even improve it in the long run.

Keep in mind, also, how a personal loan can affect your credit if you’re thinking about getting a mortgage in the future.

A personal loan can have a negative or positive effect on your credit score and overall credit standing. Before taking on debt in the form of a personal loan, consider your personal finances and whether your budget can handle the structured, monthly payments on the new loan. Do your research, evaluate your situation and make sure a personal loan is the best option for you. The more confident you feel about your finances when taking on the debt, the more you can enjoy the positive side to this type of financing.

When you’re ready to apply for a personal loan, get started with Rocket Loans℠.