Do Personal Loans Affect Your Credit Score?

A personal loan provides a lump sum of money repaid through fixed monthly installments over a set period. These loans are typically unsecured, meaning they do not require collateral such as property. A credit score, a numerical representation of an individual’s creditworthiness, serves as a key indicator of financial health. Personal loans can influence this score from the initial application to the final repayment.

Applying for a Personal Loan and Your Credit Score

The process of applying for a personal loan initiates actions that can temporarily impact a credit score. When a lender assesses an application, they typically perform a “hard inquiry” on a credit report. This hard inquiry appears on the credit report for up to two years, though its direct effect on the credit score usually diminishes after 12 months. The immediate impact on a score is generally minor, often resulting in a decrease of fewer than five points.

Opening a new credit account, including a personal loan, also affects the average age of a person’s credit accounts. A newer account can lower this average, especially for individuals with a limited credit history. While this component of a credit score is not as heavily weighted as payment history, it can still contribute to a temporary, slight reduction in the score. This effect is typically short-lived, with scores often recovering as timely payments are made.

How an Active Personal Loan Impacts Your Credit Score

The most substantial and ongoing influence a personal loan has on a credit score stems from payment behavior. Consistent, on-time monthly payments demonstrate financial responsibility and significantly contribute to a positive payment history, which is the most influential factor in credit scoring models, accounting for approximately 35% to 40% of the score. Conversely, missed or late payments, particularly those 30 days or more overdue, can severely harm a credit score and remain on the credit report for up to seven years.

The total amount owed is another factor considered by credit scoring models. While personal loans are installment debts with a fixed repayment schedule, adding a new loan increases an individual’s overall debt burden. However, as the loan balance is systematically paid down with each on-time installment, the amount owed decreases, which can positively influence this component of the credit score. Lenders also evaluate how much of the original loan amount remains outstanding.

A personal loan can also enhance a person’s credit mix. This factor assesses the diversity of credit accounts, such as a combination of revolving credit (like credit cards) and installment loans. Successfully managing different types of credit demonstrates broader financial capability and can positively impact the credit mix, which accounts for about 10% of a FICO Score. While a new loan initially lowers the average age of accounts, as the loan matures with responsible payments, it contributes to the overall length of credit history.

Paying Off a Personal Loan and Your Credit Score

Successfully paying off a personal loan in full is recorded as a positive milestone on a credit report. This action demonstrates a borrower’s ability to manage debt responsibly and fulfill their financial obligations. The account does not immediately disappear from the credit report upon payoff. Instead, it typically remains on the report for an extended period, generally up to 10 years if the account was in good standing with a history of on-time payments, or seven years if there were any negative marks.

During the time the closed account remains on the credit report, it continues to contribute to the payment history and the overall length of credit history. The completion of the loan also reduces the total amount of debt an individual carries, which can further benefit the “amounts owed” component of their credit score. While paying off an installment loan might subtly shift the credit mix, the positive impact of a successfully repaid loan outweighs this minor adjustment.