Do Personal Loans Hurt Your Credit Score?

A personal loan provides a lump sum of money that is repaid over a set period, typically with a fixed interest rate and stable monthly payments. Lenders issue these loans based on a borrower’s creditworthiness. A credit score, a three-digit number usually ranging from 300 to 850, indicates an individual’s credit risk and likelihood of repaying bills on time. This score influences whether lenders approve new accounts and determines the interest rates and terms offered. Understanding how a personal loan interacts with this financial indicator is important, as it can have both positive and negative effects on a credit score.

How a Personal Loan Influences Credit Score Components

A personal loan, as a type of installment credit, impacts various components that collectively form a credit score. Credit scoring models, such as FICO and VantageScore, assess different aspects of a consumer’s credit behavior. FICO scores, used by lenders, consider payment history as 35%, amounts owed as 30%, length of credit history as 15%, new credit as 10%, and credit mix as 10%. VantageScore models also prioritize payment history (around 40%), with depth of credit (age and type of accounts) at 21% and credit utilization at 20%.

Payment history holds the most weight in credit score calculations for both FICO and VantageScore. When a personal loan is acquired, consistent, on-time payments contribute positively to this component, demonstrating responsible financial behavior. Each successful monthly payment adds to a positive payment record, improving a credit score over time. Conversely, even a single late payment reported to credit bureaus can negatively impact a credit score, with more severe consequences for payments delayed by 30 days or more.

The “amounts owed” or “credit utilization” component, a substantial portion of a credit score, is affected differently by personal loans compared to revolving credit like credit cards. While credit utilization typically refers to the percentage of available revolving credit being used, a personal loan is an installment loan with a fixed balance that decreases with each payment. Although taking on a personal loan initially adds to total debt, reducing the principal balance over time is viewed favorably by scoring models. Using a personal loan to consolidate high-interest credit card debt can also lower credit utilization on revolving accounts, which can lead to a credit score boost.

The length of credit history, considering the age of accounts and average age of all accounts, is influenced by opening a new personal loan. A new loan will generally decrease the average age of a consumer’s credit accounts, which can cause a minor, temporary dip in the score, especially for individuals with a limited credit history. However, as the personal loan ages and is managed responsibly, it contributes to a longer, more established credit history. This long-term positive effect can outweigh the initial minor impact from a new, younger account.

Credit mix, a component in credit scoring, assesses the diversity of credit accounts a consumer manages. Having a combination of different credit types, such as revolving credit (like credit cards) and installment credit (like personal loans, auto loans, or mortgages), can positively influence a score. A personal loan adds an installment account to a credit profile, demonstrating the ability to handle different financial obligations. This diversity signals to lenders that an individual can responsibly manage various forms of debt, which can enhance creditworthiness.

The “new credit” component, which includes recent inquiries and newly opened accounts, is affected when a personal loan is obtained. Applying for a new loan triggers a hard inquiry, recorded on a credit report. While this factor accounts for a smaller percentage of the overall score, it can still cause a slight, temporary reduction. However, if the new personal loan helps diversify a credit profile or leads to better management of other debts, its long-term benefits to the credit score can be positive.

Credit Score Changes During the Application Phase

When a consumer applies for a personal loan, the initial phase involves actions that immediately affect their credit score. Lenders typically perform a “hard inquiry” or “hard pull” to assess creditworthiness, which appears on a credit report. A hard inquiry can cause a small, temporary drop in a credit score, usually by a few points, such as less than five points off a FICO Score.

Hard inquiries remain on a credit report for up to two years, but their impact on a credit score typically diminishes after the first year. While multiple hard inquiries for specific types of loans, like auto or mortgage loans, within a short period (e.g., 14 to 45 days) are often counted as a single inquiry by scoring models, this exception usually does not apply to personal loans. Therefore, applying for multiple personal loans simultaneously could result in several distinct hard inquiries, each potentially causing a minor score reduction. It is best to space out credit applications to avoid a more severe negative impact.

Opening a new credit account, such as a personal loan, can lead to an initial, minor fluctuation in a credit score. A new account lowers the average age of all credit accounts in a consumer’s credit history. Since the length of credit history is a factor in credit scoring models, a younger average age can slightly reduce the score. This effect is usually temporary and less pronounced for individuals with an already established and lengthy credit history.

The immediate score changes during the application phase are typically short-lived. Consumers often see a slight dip due to the hard inquiry and the new account’s effect on the average age of accounts. However, these initial fluctuations are not indicative of the long-term impact, which largely depends on how the personal loan is managed after approval. The temporary nature of this initial impact means that responsible loan management can quickly mitigate any negative effects.

Sustaining a Healthy Credit Score Through Loan Repayment

Once a personal loan is obtained, its ongoing management becomes a key factor in its long-term effect on a credit score. Consistently making on-time payments on a personal loan is essential for building and maintaining a strong credit score. Each timely payment demonstrates financial responsibility and contributes positively to the credit report.

Conversely, missing payments can damage a credit score. A single late payment, especially if it is 30 days or more past due, can cause a significant drop in score and remain on the credit report for up to seven years. Prioritizing timely payments for the personal loan and all other financial obligations ensures a positive credit trajectory. Setting up automatic payments can help prevent missed due dates and reinforce a positive payment history.

As the personal loan balance is paid down, it positively influences the “amounts owed” component of a credit score. While personal loans are installment credit and do not have a credit utilization ratio in the same way revolving credit does, reducing the overall debt burden is always beneficial. A decreasing loan balance reflects responsible debt management and can indicate a lower risk to lenders. This steady reduction contributes to an improved financial profile over the loan’s term.

Successfully completing the loan term and paying off the personal loan in full further contributes to a positive credit history. This demonstrates the ability to manage and fulfill a long-term financial commitment. While some individuals might experience a small, temporary dip in their score immediately after paying off a loan due to the account closing and its effect on the average age of accounts, the overall positive history established through responsible repayment typically outweighs this minor impact. The long-term benefit of a well-managed personal loan lies in its contribution to a diverse credit history, opening doors to more favorable financial opportunities.