Does Getting a Loan Lower Your Credit Score?

A credit score is a numerical representation, typically a three-digit number between 300 and 850, that assesses an individual’s credit risk and the likelihood of repaying borrowed funds on time. Lenders and creditors rely on these scores, among other factors, to determine eligibility for new accounts, interest rates, and other loan terms. A higher credit score generally leads to more favorable lending conditions, including lower interest rates and reduced fees, which can result in significant savings over the life of a loan. Understanding how obtaining a loan influences this score involves navigating several interconnected factors, rather than a simple yes or no answer.

Initial Impact of Applying for a Loan

When an individual applies for a loan, the initial effect on a credit score typically involves a “hard inquiry” or “hard pull.” This occurs when a lender requests to review a credit report as part of the application process. Hard inquiries are recorded on the credit report and can remain for up to two years, though their influence on a credit score usually diminishes after about one year. A single hard inquiry generally results in a minor, temporary dip in a credit score, often by fewer than five points. This impact is usually negligible and temporary, with scores often rebounding quickly with responsible credit behavior.

However, multiple hard inquiries in a short period, especially for credit cards, could signal increased risk to lenders and potentially lead to a larger temporary score reduction. For certain loans like mortgages, auto loans, or student loans, multiple inquiries within a specific timeframe (typically 14 to 45 days) are often grouped and counted as a single inquiry to mitigate this effect, allowing consumers to rate shop.

Another initial factor is the slight reduction in the “average age of accounts” when a new loan account is opened. A new account has an age of zero, which can pull down the average age of all accounts, particularly for individuals with a shorter credit history. While this can cause a temporary, minor decline in the score, the impact is less significant for those with a long-established credit history. Over time, as the new account ages and is managed responsibly, it contributes positively to the overall length of credit history.

How Loans Influence Credit Score Categories

The presence and management of a loan interact with several major credit score components over time. Payment history, which carries the most weight in credit scoring models (approximately 35% of a FICO Score), is significantly impacted by loan payments. Consistent, on-time payments on a loan demonstrate financial responsibility and are highly beneficial for building and maintaining a positive credit score. Conversely, late or missed payments can severely damage a credit score and remain on a credit report for up to seven years.

Credit utilization is another important factor, typically accounting for about 30% of a FICO Score, and it measures the amount of credit used relative to the total available credit. While credit utilization primarily pertains to revolving credit, like credit cards, installment loans do not directly factor into this ratio. However, taking out an installment loan can influence overall debt levels, and if used to consolidate revolving debt, it can significantly lower the credit utilization ratio by converting revolving balances into an installment loan balance. Paying down an installment loan reduces the outstanding balance, which can positively affect the “amounts owed” category.

The length of credit history, comprising about 15% of a FICO Score, considers factors such as the age of the oldest account, the age of the newest account, and the average age of all accounts. While opening a new loan might initially reduce the average age of accounts, maintaining the loan over its term eventually contributes to a longer credit history. A longer history of responsible credit use generally indicates lower risk to lenders.

Credit mix, accounting for approximately 10% of a FICO Score, considers the diversity of credit types an individual manages. Having a combination of different credit types, such as both installment loans (like mortgages or auto loans) and revolving credit (like credit cards), can be viewed favorably by credit scoring models. This demonstrates the ability to handle various forms of debt responsibly.

New credit, also making up about 10% of a FICO Score, evaluates how frequently new accounts are opened. While applying for a new loan can result in a hard inquiry and a temporary score dip, the impact is generally small and short-lived. Rapidly opening multiple new accounts, especially for individuals with limited credit history, can signal higher risk. However, responsibly managing a new loan, including making consistent on-time payments, can mitigate this initial negative effect and ultimately contribute to long-term credit improvement.

Specific Loan Types and Credit Impact

Different types of loans exhibit varying impacts on a credit score due to their unique structures and repayment terms. Mortgage loans, for instance, are typically large and have long repayment periods, often spanning decades. Obtaining a mortgage can cause a temporary decrease in a credit score due to the hard inquiry and the significant increase in overall debt. However, consistent and timely mortgage payments are highly beneficial, establishing a strong payment history and contributing significantly to long-term credit health. Mortgages also enhance credit mix by adding a substantial installment account.

Auto loans are another common installment loan type, typically smaller in scale than mortgages but still involving consistent fixed payments over several years. Similar to mortgages, applying for an auto loan results in a hard inquiry and a slight, temporary score dip. The most significant factor for an auto loan’s impact on credit is the borrower’s payment behavior; making all payments on time helps improve the credit score. An auto loan also contributes to a diversified credit mix, especially if it is an individual’s first installment loan.

Personal loans, which can be secured or unsecured, also function as installment loans with fixed repayment schedules. The application for a personal loan leads to a hard inquiry, causing a small, temporary score reduction. While a personal loan adds to the total debt, it can positively affect a credit score if used to consolidate higher-interest revolving debt, thereby lowering credit utilization. Consistent, on-time payments on a personal loan build positive payment history, which is a major factor in credit scoring.

Student loans, like other installment loans, typically have long repayment periods and fixed monthly payments, though payment schedules may be deferred while a student is in school. On-time payments for student loans are crucial for establishing and building a positive credit history. Student loans contribute to the length of credit history and diversify the credit mix, particularly for younger individuals who may have limited other credit accounts. Conversely, missed payments can significantly harm credit scores, with federal student loan servicers typically reporting delinquencies after 90 days, while private lenders may report after 30 days.