Do Personal Loans Hurt Your Credit Score?

A personal loan can provide funds for various needs, from consolidating high-interest debt to financing a significant purchase. Understanding how these loans interact with your credit score is important, as credit scores represent your creditworthiness, influencing access to future credit and interest rates. The relationship between a personal loan and your credit score is not straightforward; it involves factors that can temporarily lower your score or contribute to its improvement over time.

The Initial Credit Inquiry

When you apply for a personal loan, lenders typically perform a “hard inquiry” on your credit report to assess your creditworthiness. This can temporarily cause a small dip in your credit score, usually fewer than five points. While a hard inquiry remains on your credit report for up to two years, its impact typically lessens after a few months and generally only affects the score for about 12 months.

It is important to distinguish a hard inquiry from a “soft inquiry,” which occurs when you check your own credit score or when lenders pre-approve you for offers. Soft inquiries do not affect your credit score. If you are “rate shopping” for a personal loan, some credit scoring models may treat multiple inquiries for the same type of loan within a specific timeframe as a single inquiry. This “shopping period” can range from 14 to 45 days, helping to mitigate the negative impact of comparing loan offers.

Adding a New Account to Your Credit Profile

Once a personal loan is approved and reported, it becomes a new account on your credit profile, influencing your credit score through various components. One component is the “length of credit history,” which accounts for approximately 15% of your FICO Score. Adding a new loan can decrease the average age of your credit accounts, particularly if your existing credit history is short. However, as the new loan ages, its presence can eventually contribute positively to your credit history length.

The addition of a personal loan also impacts your “credit mix,” which constitutes about 10% of your FICO Score. Credit mix refers to the variety of credit types you manage, such as revolving credit (like credit cards) and installment credit (like personal loans, auto loans, or mortgages). If your credit profile primarily consists of revolving accounts, adding an installment loan can be viewed favorably by scoring models, demonstrating your ability to manage different kinds of debt.

Furthermore, a new personal loan directly affects the “amounts owed” category, which makes up about 30% of your FICO Score. While a personal loan adds to your total debt, it is an installment loan with a fixed repayment schedule. Unlike revolving credit, where high utilization ratios (the amount owed relative to the credit limit) can negatively impact scores, installment loans are assessed differently. Scoring models evaluate the balance of the installment loan against its original amount, and as the loan is paid down, this balance decreases, which can be viewed positively.

The Impact of Ongoing Repayment

The most substantial and lasting effect of a personal loan on your credit score comes from your repayment behavior. “Payment history” is the most significant factor in credit scoring, accounting for 35% of your FICO Score and 40% of your VantageScore. Consistently making on-time payments demonstrates responsible credit management and significantly contributes to building and maintaining a strong credit score over the loan’s term. Each on-time payment reinforces a positive financial habit and is recorded on your credit report.

Conversely, late payments can severely damage your credit score. Lenders typically report payments as late once they are 30 days or more past due. A single payment reported 30 days late can cause a substantial drop in your credit score, potentially ranging from 60 to 110 points. The longer a payment remains overdue (e.g., 60, 90, or 120 days late), the more severe the negative impact becomes. These negative marks can remain on your credit report for up to seven years.

As you diligently pay down the principal balance of your personal loan, it positively influences your credit score in the “amounts owed” category. Reducing the outstanding balance of an installment loan demonstrates a decreasing debt burden. While paying off the last active installment loan might sometimes lead to a temporary small dip in score due to account closure and its impact on credit mix and average account age, the overall positive payment history and reduced debt burden typically outweigh this minor effect.