Does Getting a Loan Affect Your Credit?

A credit score summarizes an individual’s creditworthiness, reflecting financial habits and debt management. It provides lenders with a quick assessment of risk when evaluating applications. Obtaining a loan can influence credit, presenting opportunities for positive development or potential negative impacts, depending on how the new credit is managed.

Applying for a Loan and Its Immediate Effect

Applying for a loan often triggers a “hard inquiry” on your credit report. This occurs when a lender requests to review your credit file to assess creditworthiness. Hard inquiries are recorded and typically remain visible for up to two years, though their influence on scores usually lasts about one year.

A single hard inquiry typically results in a small, temporary dip in your credit score, often by five points or less. Multiple hard inquiries in a short timeframe can signal increased risk to lenders, potentially leading to a more noticeable score drop.

Credit scoring models, such as FICO and VantageScore, recognize that consumers often shop for the best rates. To accommodate this, multiple inquiries for the same loan type (e.g., mortgage, auto, student) made within a specific window are often grouped as a single inquiry. This ‘rate shopping’ period, typically 14 to 45 days, allows individuals to compare offers without unduly penalizing their credit scores.

The Addition of a New Account to Your Profile

Once approved, a new loan influences your credit profile. One influence is on the ‘average age of accounts,’ a factor in credit scoring models. Adding a new loan, especially for those with long-established credit histories, can lower this average age, potentially causing a minor, temporary negative impact on their score.

A new loan also affects ‘credit mix.’ Credit scoring models consider the diversity of credit types an individual manages. Introducing a new credit type, such as an installment loan if the borrower previously only had revolving credit, can broaden the credit profile. This diversification can be viewed favorably over time, demonstrating the ability to responsibly manage different forms of debt.

While a new account might initially cause a slight decrease due to a shorter average age of accounts, responsible management can lead to long-term benefits. Over time, a well-managed new account can help build a stronger and more diverse credit history.

The Role of Payment Behavior

Payment history is the most significant factor influencing credit scores. It demonstrates reliability in meeting financial obligations. Consistently making on-time payments on all credit accounts, including loans, positively impacts scores by building a strong credit history. This consistent behavior signals lower risk to lenders.

Conversely, late or missed payments have severe negative consequences for credit scores. Payments are typically not reported as late until 30 days past due. Once reported, these negative marks significantly lower a score, especially if the individual previously had good credit. The longer a payment is overdue, the more severe the impact.

Negative marks, such as late payments, can remain on a credit report for up to seven years from the original delinquency date. While their impact lessens over time with on-time subsequent payments, they still affect creditworthiness. Maintaining a diligent payment schedule is paramount for a healthy credit profile.

How Loan Types Affect Credit

Different loan types impact credit profiles uniquely, primarily installment loans and revolving credit. Installment loans (e.g., mortgages, auto, student, personal) involve borrowing a fixed amount repaid over a set period through regular payments. The original loan amount and consistent balance reduction through on-time payments contribute positively to the credit score. Successfully paying off an installment loan demonstrates responsible credit management.

Revolving credit (e.g., credit cards, HELOCs) allows borrowers to repeatedly draw from and repay a credit limit. A significant factor is the ‘credit utilization ratio’ – the amount of credit used compared to total available credit. Keeping this ratio low, generally below 30%, is beneficial for credit scores. High utilization indicates increased risk and negatively affects scores.

Both loan types can positively influence a credit score with responsible use, though revolving credit often has a more pronounced impact on the credit utilization ratio. A mix of installment and revolving accounts contributes to a stronger credit profile, demonstrating the ability to manage various forms of debt. The key for both remains consistent, on-time payments.