Does Getting a Loan Hurt Your Credit Score?

Obtaining a loan often raises questions about its potential impact on one’s credit score. A loan’s effect involves immediate adjustments and long-term management practices. Understanding these dynamics is important for anyone considering new financing.

Initial Credit Score Adjustments

When an individual applies for a loan, an immediate, short-term effect on their credit score occurs due to a hard inquiry. A hard inquiry happens when a lender checks an applicant’s credit report. Each hard inquiry can temporarily lower a credit score by a few points. While hard inquiries can remain on a credit report for up to two years, their impact diminishes or disappears within 12 months.

Applying for multiple loans of the same type, such as auto or mortgage loans, within a concentrated period, generally 14 to 45 days, is often treated as a single inquiry by scoring models. This practice, known as rate shopping, allows consumers to compare loan terms without cumulative negative effects from multiple inquiries. However, applying for different types of loans, such as a mortgage and a credit card, might result in separate inquiries, each potentially affecting the score.

Opening a new loan account can also lead to a temporary dip in a credit score. This adjustment occurs because the new account lowers the average age of all credit accounts. A newer account can make the overall credit history appear shorter, which may be viewed less favorably in the short term. However, this initial decrease is minor and recovers with responsible management of the new loan.

Long-Term Credit Score Influences

The primary influence a loan has on a credit score unfolds over the entire repayment period, primarily through payment history. Consistent, on-time payments are the primary positive factor for a credit score, demonstrating reliable financial behavior. Payment history typically accounts for 35% of a FICO Score, making it the largest determinant. Every timely payment contributes to a positive credit record, which can gradually improve one’s score.

Conversely, missed or late payments can damage a credit score. A payment reported 30 days past its due date can cause a score drop, with more severe impact for later payments. These negative marks can remain on a credit report for up to seven years from the date of the first delinquency. If a loan becomes severely delinquent, it may be charged off by the lender or sent to collections, which can have a more detrimental effect on a credit score. Negative information’s impact lessens over time, particularly with subsequent on-time payments.

Another factor influenced by a loan is the credit mix, which refers to the variety of credit accounts an individual manages. Adding an installment loan, such as a mortgage or auto loan, can diversify a credit portfolio, especially if the individual primarily has revolving credit. A diversified credit mix indicates an ability to responsibly manage different types of debt.

For installment loans, the “amounts owed” factor considers the original loan amount and the diminishing balance. Paying down the loan balance over time positively impacts this category. This differs from revolving credit, which focuses on the credit utilization ratio. While total debt increases when a loan is first taken out, consistent reduction of the principal balance demonstrates responsible debt management.

The length of credit history also plays a role in credit scoring. Although opening a new loan initially lowers the average age of accounts, as the loan ages and is managed responsibly, it contributes positively to the overall length of credit history. A longer history of responsible credit use is seen as favorable by lenders.

Specific Loan Type Impacts

Mortgage loans have a substantial impact on credit scores. Consistent, long-term on-time payments on a mortgage can improve a credit profile due to the loan’s size and extended repayment period. A high credit score is important for securing favorable mortgage interest rates and terms.

Auto loans are secured installment loans with shorter terms than mortgages. On-time payments on an auto loan contribute positively to payment history. Conversely, late payments or defaulting can lead to negative consequences, including potential vehicle repossession.

Personal loans, which can be secured or unsecured, influence credit scores. Responsible management, including consistent on-time payments, can improve credit over time. Personal loans are sometimes used for debt consolidation, which can positively impact credit utilization by converting revolving debt into installment debt.

Student loans often have deferred payment starts and very long repayment periods. They function as installment loans and appear on credit reports. Making on-time payments on student loans can establish or build a positive credit history. However, missed or late student loan payments can negatively impact credit scores, with severe delinquency leading to drops.