Does Taking a Personal Loan Hurt Your Credit Score?

A personal loan provides a lump sum of money repaid over a set period with fixed payments. Understanding its impact on your credit score is important, as it depends on factors from the loan application to your repayment behavior. The process involves several stages, each with distinct implications for your credit profile.

The Impact of Loan Application

When you apply for a personal loan, lenders perform a “hard inquiry” on your credit report. This occurs when a financial institution checks your credit history to make a lending decision, and you provide authorization for this action. A hard inquiry serves as a record that you sought new credit and can remain on your credit report for up to two years. Its negative effect on your credit score diminishes after 12 months.

A single hard inquiry results in a small, temporary dip in your credit score, often by fewer than five points. This minor reduction is short-lived, especially if the loan is approved and managed responsibly. However, multiple hard inquiries in a short period can signal to lenders that you may be a higher risk, potentially leading to a greater impact on your score.

Soft inquiries, such as checking your own credit or pre-qualifying for an offer, do not affect your credit score. These checks provide an overview of your creditworthiness without the same implications as a formal loan application.

How a New Loan Affects Your Credit Profile

Once a personal loan is approved and reported, its presence on your credit report influences your credit profile. Opening any new credit account, including a personal loan, can temporarily lower the average age of your credit accounts. Since credit history length is a factor in credit scoring, a shorter average age can slightly reduce your score initially. However, this effect lessens over time as the new account ages and contributes to a longer credit history.

A personal loan, an installment loan, can also affect your credit mix. If your existing credit primarily consists of revolving accounts, such as credit cards, adding an installment loan can diversify your credit portfolio. Lenders view a healthy mix of different credit types favorably, as it demonstrates your ability to manage various forms of debt responsibly. This diversification can be a positive factor in your credit score.

Personal loans do not directly factor into the revolving credit utilization ratio like credit cards do. This ratio measures the amount of available revolving credit you are using, which is a significant factor in credit scoring. While a personal loan doesn’t impact this specific percentage, it adds to your overall debt burden, which lenders consider when assessing your debt-to-income (DTI) ratio. A higher DTI ratio can influence a lender’s perception of your ability to take on additional debt. If a personal loan is used for debt consolidation, it can indirectly improve your credit utilization by reducing balances on revolving accounts, though the total debt amount remains.

The Long-Term Influence of Repayment Behavior

Your repayment behavior is the most significant factor influencing a personal loan’s long-term impact on your credit score. Payment history accounts for approximately 35% of your FICO Score, making it the largest contributing factor. Consistently making on-time payments demonstrates financial responsibility and builds a positive payment record, steadily improving your credit score and showing lenders you are a reliable borrower.

Conversely, late payments, missed payments, or defaulting on the loan can severely damage your credit score. A payment is considered late and reported to credit bureaus once it is 30 days past its due date. The longer a payment remains overdue, the more severe the negative impact. Late payments can stay on your credit report for up to seven years from the original delinquency date, significantly affecting your creditworthiness.

Once a personal loan is fully paid off, the account will close or mature. Even after closure, the positive payment history can continue to benefit your credit score for many years, typically up to 10 years, as it remains on your credit report. While some individuals might experience a temporary, slight dip in their score immediately after paying off a loan, this effect is minor and short-lived. The overall benefit of a positively managed loan on your credit history outweighs any temporary fluctuations.