How Personal Loans Affect Your Credit Score

They can help raise your score, but they have to be repaid on time

Reviewed by Thomas BrockFact checked by Kirsten Rohrs SchmittReviewed by Thomas BrockFact checked by Kirsten Rohrs Schmitt

A personal loan can affect your credit score in several ways⁠—both good and bad. Taking out a personal loan isn’t bad for your credit score in and of itself. However, it may affect your overall score in the short term and make it more difficult for you to obtain additional credit until the loan is repaid.

On the other hand, paying off a personal loan on time should boost your overall score. If you decide to take one out, thoroughly research and compare all of your options to qualify for the best possible loan, even if you have bad credit.

Key Takeaways

• Your overall credit rating could temporarily drop when you take a personal loan because you have acquired additional debt. 
• In the short term, you also may not be able to get another loan or open another credit card.
• However, repaying the loan on time will not only bring your credit score back up, but it can also help build it over time.
• You don’t need an excellent credit score to get a loan—you can apply for a personal loan with a fair credit score.

How Applying for Loans Affects Your Credit Score

Your credit score is calculated based on five factors: payment history, amounts owed, length of credit history, new credit, and credit mix.

The exact percentages vary among the three major credit rating agencies, but according to FICO, 10% is based on any new debt or newly opened lines of credit, and another 10% is based on credit mix—the number of credit lines that you have open (including secured credit cards). As such, obtaining a new personal loan could affect your credit rating. Your outstanding debt total has now increased, and you have acquired new debt.

Credit agencies also take note of new financial activity. If, for example, you tried to apply for an auto loan shortly after taking out a personal loan, your application might be rejected because you already have as much debt as you can handle.

Your overall credit history has more impact on your credit score than a single new loan. If you have a long history of managing debt and making timely payments, your score shouldn’t be affected for very long. The easiest and best way to keep a personal loan from lowering your credit score is to make your payments on time and within the terms of the loan agreement.

Important

The three major credit reporting bureaus in the United States that lenders turn to—Equifax, Experian, and TransUnion—provide similar scores on your creditworthiness, but there can be slight differences.

How Do People Use Personal Loans?

Investopedia commissioned a national survey of 962 U.S. adults between Aug. 14, 2023, and Sept. 15, 2023, who had taken out a personal loan to learn how they used their loan proceeds and how they might use future personal loans. Debt consolidation was the most common reason people borrowed money, followed by home improvement and other large expenditures.

How a Personal Loan Can Boost Your Credit Score

A personal loan you repay in a timely fashion can positively affect your credit score, demonstrating that you can handle debt responsibly.

Unfortunately, those who are the most averse to taking on debt could have lousy credit scores. After all, a person who never acquires debt and pays it off in installments has no payment history.

Note

You can receive a free copy of your credit reports from the three credit bureaus every 12 months, which you can get by visiting www.AnnualCreditReport.com.

What Credit Score Is Needed for a Personal Loan?

FICO scores fall into five categories—poor, fair, good, very good, and exceptional. Here’s a breakdown of the ranges:

• Poor (<580): Below average, lenders will consider you a risky borrower.
• Fair (580–669): Below average, but many lenders may still approve loans with this score.
• Good (670–739): Near or slightly above average, and most lenders view this as a good score.
• Very Good (740–799): Above average and shows lenders that you are a dependable borrower.
• Exceptional (800+): Well above average, and lenders will view you as an exceptional borrower.

The higher your credit score, the more likely a lender will approve your loan application and offer more favorable terms, such as a lower interest rate. While each has its own criteria, lenders generally view scores above 670 as an indication that a borrower is creditworthy.

Also, keep in mind that while your credit score plays a crucial role in helping you qualify for a personal loan, lenders also consider other factors like the amount of income you earn, how much money you have in the bank, and how long you have been employed.

Finding the right loan can be particularly stressful when you face a financial emergency and need to borrow money quickly. Accessing cash in a hurry may seem even more daunting if you have bad credit. Fortunately, you may still be able to secure an emergency loan even when you have credit problems.

Frequently Asked Questions (FAQs)

What Can I Use a Personal Loan For?

Money from a personal loan can be used for various things. Some examples include using it to pay your tax debts, finance home renovations, or cover an unexpected medical emergency.

What Rate Will I Get for a Personal Loan?

Your loan rate will depend on your credit score and credit history. The higher your score and the better the history, the lower your interest rate and monthly payments will be. The average rate for a 24-month personal loan was 11.92% in May 2024.

Does Taking Out a Personal Loan Hurt my Credit Score?

Your credit score will take a slight hit when you apply for a loan, as the lender looks hard at your credit. However, your credit score should improve if you make your payments on time.

The Bottom Line

A personal loan will cause a slight hit to your credit score in the short term, but making on-time payments will bring it back up and can help improve your credit in the long run. A personal loan calculator can help determine the loan repayment term that’s right for you.

Your credit score will be hurt if you pay late or default on the loan. And don’t forget that a personal loan may also reduce your borrowing power for other lines of credit. If you’ve recently taken out a personal loan and accidentally made multiple late payments or defaulted on the said loan, one of the best credit repair companies might be able to help remove the negative marks on your credit report.

Read the original article on Investopedia.