How Does a Loan Affect Your Credit Score?

A credit score provides a numerical representation of an individual’s creditworthiness, serving as a key indicator for lenders when evaluating loan applications and determining terms. These scores are compiled from information within credit reports, which document an individual’s credit activities. Loans significantly influence credit score calculation. Understanding this relationship is important for managing financial health and accessing favorable lending opportunities.

Credit Inquiries and New Loans

Applying for a new loan initiates a “hard inquiry” on a credit report, a formal request by a lender to review credit history. This inquiry can result in a small, temporary decrease in a credit score, often by about five points. While a hard inquiry remains on a credit report for up to two years, its impact diminishes after about 12 months.

Multiple hard inquiries for the same loan type (e.g., mortgage, auto loan) within a short period (14-45 days) are often treated as a single inquiry by credit scoring models. This allows consumers to shop for the best rates without penalizing their score for each comparison. Applying for multiple different types of credit (e.g., various credit cards) within a short timeframe can lead to multiple distinct hard inquiries, signaling higher risk. Opening a new loan account also affects a credit score by altering the average age of all credit accounts. A new, young account can lower this average, potentially causing a minor score adjustment. This new account also contributes to the “new credit” category, which accounts for approximately 10% of a FICO Score.

Ongoing Loan Repayment and Credit Scores

Consistent, on-time payments on a loan are essential for building positive credit history and improving a credit score. Payment history is the most influential factor in credit scoring models, typically accounting for 35% of a FICO Score. Each timely payment adds favorable information to a credit report, demonstrating reliability. This positive track record helps lenders assess a lower risk when considering future credit applications.

Conversely, late payments, missed payments, or defaults can severely damage a credit score. Payments reported 30 days or more past due to credit bureaus can damage scores. The negative impact increases with lateness; 60-day or 90-day delinquencies cause more significant score drops than 30-day late payments. Such negative marks can remain on a credit report for up to seven years, significantly hindering access to new credit or favorable terms.

The outstanding balance of an installment loan decreases with consistent payments. As the principal diminishes, it reflects responsible debt reduction and positively influences the “amounts owed” category of a credit score. This category typically constitutes 30% of a FICO Score. Paying down loan balances demonstrates a reduced debt burden, viewed favorably by credit scoring models and lenders.

The Role of Different Loan Types

The types of loans an individual manages also influence their credit score, particularly through categories like credit utilization and credit mix. Installment loans (e.g., mortgages, auto loans, student loans) involve a fixed amount repaid in regular, predetermined payments over a set period. Successful management, marked by consistent on-time payments, contributes to a stable payment history and demonstrates reliable debt management. These loans have a definite payoff date, and as the balance decreases, it reflects positively on the borrower’s ability to reduce debt.

Revolving loans (e.g., credit cards, lines of credit) allow borrowers to repeatedly draw from and repay a credit limit, with payments based on the outstanding balance. A significant factor for revolving credit is the “credit utilization ratio,” the amount of credit used relative to the total available credit. This ratio, typically expressed as a percentage, is a substantial component in credit scoring, often making up 30% of a FICO Score. Maintaining a low credit utilization ratio (generally below 30% of the available credit limit) is beneficial for a credit score.

Having a “credit mix” that includes both installment and revolving accounts, managed responsibly, can positively influence a credit score. This demonstrates an individual’s ability to handle various forms of credit effectively, contributing to the “credit mix” factor, which accounts for about 10% of a FICO Score. A diverse and well-managed credit portfolio indicates broader financial experience.