Does Taking Out a Loan Hurt Your Credit Score?

A credit score numerically evaluates an individual’s creditworthiness. This three-digit number, typically ranging from 300 to 850, indicates the likelihood of a borrower repaying a loan on time. Lenders rely on credit scores to assess risk, as a higher score generally signifies lower risk and can influence loan terms and interest rates.

The Initial Impact of Taking Out a Loan

Applying for a new loan can cause a temporary, minor dip in a credit score. This initial impact is primarily due to a “hard inquiry” on your credit report. A hard inquiry occurs when a lender requests your credit report to evaluate your application, signaling to credit bureaus that you are seeking new credit.

While a single hard inquiry typically has a small effect on your score, its impact is usually temporary. Credit scoring models recognize that consumers often “rate shop” for the best loan terms. Therefore, multiple inquiries for the same type of loan within a short timeframe are often grouped and treated as a single inquiry.

Opening a new loan account also influences your “length of credit history” and “credit mix.” A new account can reduce the average age of your overall credit accounts, slightly lowering your score initially. However, it can also positively diversify your credit mix by adding a different type of credit, benefiting you over time. The temporary dip from a new loan is generally short-lived, especially if the loan is managed responsibly from the outset.

Ongoing Loan Management and Your Credit Score

Your ongoing management of a loan account has the most substantial and lasting influence on your credit score. Payment history is the most significant factor in credit scoring, accounting for approximately 35% of your score. Consistently making on-time payments demonstrates financial responsibility and builds a positive credit history over time.

Conversely, late or missed payments can severely damage your credit score, with the impact increasing based on their lateness and frequency. Even a single payment reported as 30 days past due can have a negative effect. These negative marks remain on your credit report for several years, influencing your score for an extended period.

The amount owed on your loans also plays a role. For installment loans, consistently reducing the principal balance positively impacts your score as your debt burden decreases. Maintaining low balances relative to your credit limits, especially on revolving credit, is generally favorable for your score.

The length of your credit history benefits from keeping older accounts open and in good standing. A long history of responsibly managed loans shows stability and experience with credit. Additionally, having a diverse “credit mix” of different loan types, such as installment loans and revolving credit, can positively impact your score.

Loan Types and Their Specific Credit Considerations

Different loan types are viewed uniquely by credit scoring models based on their structure and repayment mechanisms. Installment loans, such as mortgages, auto loans, and personal loans, involve fixed payments over a set period. Successful, on-time repayment of these loans consistently builds a strong positive payment history, and as the principal balance decreases, it positively impacts your amounts owed. These loans also contribute to a diverse credit mix.

Revolving credit, including credit cards and lines of credit, allows you to borrow, repay, and re-borrow up to a certain limit. For revolving accounts, “credit utilization”—the amount of credit you are using compared to your total available credit—is a significant factor. Keeping credit card balances low, ideally below 30% of the credit limit, is important for maintaining a good score. Higher utilization rates can signal increased risk to lenders.

Loans can also be categorized as secured or unsecured. Secured loans, like mortgages or auto loans, are backed by collateral the lender can seize if payments are not made. Unsecured loans, such as personal loans or credit cards, do not require collateral. While collateral affects lender risk, scoring factors like payment history and utilization remain consistent for both types, emphasizing responsible repayment.

Monitoring Your Credit and Next Steps

Regularly monitoring your credit reports and scores is important for managing your financial health after taking out loans. You are entitled to a free copy of your credit report annually from each of the three major credit bureaus: Equifax, Experian, and TransUnion. Accessing these reports allows you to review your credit history for accuracy and identify any potential errors.

You can check your credit score through credit card companies, banks, or free online services. While the specific score may vary slightly depending on the scoring model used, these tools offer a general indication of your credit standing. Regularly checking your score can help you track progress and understand the impact of your financial actions.

If you find any discrepancies or errors on your credit report, it is important to dispute them with the respective credit bureau. Promptly addressing inaccuracies helps ensure your credit profile reflects your true payment behavior. The sustained practice of making consistent, on-time payments and managing all your credit obligations responsibly remains the most effective strategy for maintaining and improving your credit health over time.