Does Getting a Personal Loan Hurt Your Credit?

Credit scores serve as a numerical representation of an individual’s creditworthiness, providing lenders with an assessment of the risk involved in extending credit. These scores are compiled from information within credit reports, which detail a person’s borrowing and repayment history. A higher credit score generally indicates a lower risk to lenders, which can lead to more favorable terms for loans and other financial products. Understanding how different financial actions influence these scores is important for managing one’s financial health.

Initial Impact on Credit

Applying for a personal loan typically initiates a hard inquiry on a credit report, which occurs when a lender checks an applicant’s credit history to evaluate their creditworthiness. This type of inquiry can cause a temporary, minor dip in a credit score, usually by a few points. While a hard inquiry can remain on a credit report for up to two years, its impact on the score generally diminishes after a few months. Multiple hard inquiries within a short period, often within a 14-to-45-day window depending on the scoring model, are frequently treated as a single inquiry if they are for the same type of loan, a process known as rate shopping.

The act of opening a new personal loan account can also influence the average age of an individual’s credit accounts. When a new account is added, it can temporarily lower the overall average age of all accounts, which is a factor in some credit scoring models. However, this effect is usually short-lived and tends to improve as the new account ages. For individuals with a limited credit history, a new loan can sometimes diversify their credit mix, potentially offering a minor positive influence by demonstrating the ability to manage different types of credit.

Ongoing Impact on Credit

The most substantial and enduring impact of a personal loan on a credit score stems from payment history. Consistently making on-time payments is a significant positive factor, demonstrating financial responsibility and reliability to credit bureaus. Each timely payment contributes to a positive credit history, which can gradually improve a credit score over the loan’s term. Conversely, missing a payment or making late payments can severely damage a credit score.

Late payments, especially those reported to credit bureaus after 30 days past the due date, can lead to a substantial decrease in a credit score and remain on a credit report for up to seven years. A personal loan, structured as an installment loan with fixed payments, can also influence credit utilization, particularly if used to consolidate revolving debt like credit card balances. If loan funds pay down high-balance credit cards, it can significantly lower revolving utilization, a major factor in credit scoring.

A diverse credit mix, including both installment loans and revolving credit, can be viewed favorably by credit scoring models. Successfully managing different types of credit indicates broader financial management capability. As a personal loan ages and is eventually paid off, it continues to contribute positively to the length of credit history, especially if payments were consistently on time.

Managing Credit While Taking a Personal Loan

Before applying for a personal loan, review your credit report to identify inaccuracies and understand your current credit score. This allows you to assess your credit standing and address potential issues. When shopping for a loan, submitting multiple applications within a concentrated timeframe, typically within 14 to 45 days, can help minimize the impact of hard inquiries on a credit score. This approach allows for comparing loan offers without incurring multiple significant credit score reductions.

During the loan repayment period, consistently making all payments on time is crucial. Setting up automatic payments or reminders can help ensure that due dates are not missed, which is essential for maintaining a positive payment history.

Avoid taking on substantial new debt, particularly revolving credit, immediately after or during the early stages of repaying a personal loan. Accumulating additional debt can increase your overall debt burden and potentially impact credit utilization. Regularly monitoring your credit report throughout the loan term is beneficial for tracking progress and identifying any discrepancies or fraudulent activity.

Understanding all the terms of the personal loan, including the interest rate, repayment schedule, and any associated fees, is important to avoid unexpected financial burdens that could lead to missed payments. After the personal loan is fully repaid, the account continues to contribute to the length of credit history for several years, often up to 10 years, which can be beneficial for a credit score. Avoiding the closure of other long-standing credit accounts, such as old credit cards, is recommended as these accounts contribute to the overall average age of credit history.