Does Having a Personal Loan Affect Your Credit Score?

A personal loan provides a borrower with a lump sum of money from a lender, such as a bank or credit union, which is then repaid in fixed monthly installments over a set period. These loans are often unsecured, meaning they do not require collateral like a home or car. People use personal loans for various purposes, including debt consolidation, home improvements, or unexpected expenses.

A credit score is a three-digit number, typically ranging from 300 to 850, that represents an individual’s credit risk and the likelihood of repaying debt on time. Lenders use this score to determine eligibility for credit products, such as loans and credit cards, and to establish interest rates and terms. A higher credit score generally leads to more favorable loan terms and interest rates. Having a personal loan can influence your credit score, with both immediate and long-term effects depending on its management.

Initial Credit Score Impacts

Applying for a personal loan initiates a “hard inquiry” on your credit report when a lender assesses your creditworthiness. A hard inquiry typically causes a small, temporary dip in your credit score, which usually recovers quickly. These inquiries can remain on your credit report for up to two years.

Opening a new credit account, including a personal loan, can temporarily affect your score by reducing the average age of your credit accounts. Lenders favor borrowers with a longer credit history, so adding a new account might slightly lower your score. This effect is minor and diminishes as the new account ages.

The new loan adds to your total outstanding debt, a factor credit scoring models consider. While personal loans are installment loans, not revolving credit, they contribute to your overall debt burden. An increase in total debt could be seen as an elevated risk, potentially impacting your score. However, if the loan is used for debt consolidation, paying off high-interest revolving credit can improve your score by reducing credit utilization.

Ongoing Credit Score Impacts

Payment history is the most significant factor in calculating a credit score. Consistently making on-time payments on your personal loan demonstrates responsible financial behavior. Each timely payment reported to credit bureaus contributes positively to your credit profile, improving your credit score over time. This consistent positive activity builds a reliable track record, signaling to lenders that you are a dependable borrower.

Conversely, late or missed payments can severely damage your credit score. Lenders report payments that are 30, 60, or 90 days past due to credit bureaus, and these negative marks can remain on your credit report for up to seven years. A single late payment can cause a significant drop in your score, and multiple missed payments can have a more lasting impact. Defaulting on a loan results in severe negative consequences for your credit, making it challenging to obtain new credit.

Credit utilization is another important factor. While personal loans are installment loans and do not directly factor into the credit utilization ratio like revolving credit, the balance owed is still part of your overall debt. As you pay down the principal balance, the outstanding amount decreases, which can be viewed favorably by credit scoring models. Managing this debt responsibly by reducing the balance indicates a lower risk profile.

Credit Mix Considerations

Credit mix refers to the variety of credit accounts an individual manages. This factor considers whether you have a combination of revolving credit, such as credit cards, and installment loans, like mortgages or personal loans. Credit scoring models view a diverse mix of credit types favorably. It suggests you can responsibly handle various forms of debt.

Adding a personal loan to your credit profile can diversify your credit mix, especially if your existing credit primarily consists of revolving accounts. This diversification can positively impact your credit score, assuming all accounts are managed well. Demonstrating the ability to make consistent, on-time payments across different loan types signals financial maturity to lenders.

While credit mix is a contributing factor, it holds less weight than payment history or the amount of debt owed. Its impact on your score is less pronounced than making timely payments or keeping debt levels manageable. Nevertheless, a personal loan can serve as a beneficial addition to a credit report by broadening the types of credit you have successfully managed.