Do Personal Loans Impact Credit Score?

Personal loans provide a lump sum of money repaid over a set period with fixed monthly payments. Individuals use these loans for various purposes, such as consolidating debt, funding home improvements, or covering unexpected expenses. When considering a personal loan, it is natural to wonder about its potential effects on your credit score. Personal loans can influence your credit score, presenting both opportunities for improvement and risks of negative impact, depending on how they are managed.

The Impact of Loan Applications

Applying for a personal loan typically involves a “hard inquiry” on your credit report. A hard inquiry occurs when a lender requests to review your credit file as part of your loan application. This action is recorded on your credit report and can cause a slight, temporary reduction in your credit score, usually by fewer than five points. While it remains on your credit report for up to two years, its influence on your score generally lasts for about 12 months.

Submitting multiple personal loan applications within a short timeframe can lead to several hard inquiries appearing on your credit report. Unlike inquiries for auto or mortgage loans, which credit scoring models often group, personal loan inquiries are not typically consolidated. Numerous inquiries in a short span could accumulate, signaling to lenders that you are seeking a significant amount of new credit. This may be viewed as a higher risk, leading to a more noticeable, though temporary, negative effect on your score.

How a New Loan Account Influences Your Credit Profile

Once a personal loan is approved and opened, its presence on your credit report influences your credit profile in several ways. Your credit mix, accounting for 10% of your FICO score, is one aspect. If your credit history primarily consists of revolving accounts like credit cards, adding an installment loan can diversify your credit portfolio. This diversification is viewed favorably by credit scoring models, demonstrating an ability to manage different types of credit responsibly.

Another factor is the length of your credit history, which constitutes 15% of your FICO score. Opening a new loan account can slightly reduce the average age of all your credit accounts. For individuals with an established, long credit history, this impact might be minimal. However, for those with a shorter history, a new account could have a more pronounced, temporary effect on the average age, potentially leading to a small dip in their score.

The act of opening any new credit account, including a personal loan, is categorized as “new credit” and makes up 10% of your FICO score. This event can temporarily cause a minor dip in your score. This is a common and usually short-lived effect, as credit scoring models account for consumers occasionally opening new accounts. Over time, as the account ages and is managed responsibly, this temporary impact diminishes.

The Role of Repayment Behavior

Consistent repayment behavior is the most significant determinant of your credit score, with payment history accounting for 35% of your FICO score. Making all personal loan payments on time, every month, demonstrates reliability and builds a strong positive credit history. Each on-time payment reinforces your creditworthiness, contributing to a higher score over time. This consistent positive activity is fundamental to improving your overall credit profile.

The “amounts owed” category represents 30% of your FICO score. While personal loans have a fixed repayment schedule, paying down the principal balance steadily reduces the amount owed. If a personal loan is used for debt consolidation, especially to pay off high-interest credit card balances, it can significantly improve your credit score. Reducing the credit utilization ratio on revolving credit accounts, a key component of “amounts owed,” can boost your score.

Conversely, failing to make timely payments on a personal loan can severely damage your credit score. Late payments, particularly those reported 30, 60, or 90 days past due, lead to a significant score drop. These negative marks, including missed payments, defaults, or accounts sent to collections, remain on your credit report for up to seven years from the original delinquency date. Such events signal higher risk to future lenders and can impede your ability to obtain new credit or secure favorable terms for years.