How Does a Personal Loan Affect Credit Score?

Personal loans are a common form of installment credit, providing a lump sum of money that is repaid over a set period through regular, fixed payments. A credit score serves as a numerical representation of an individual’s creditworthiness. This score helps lenders assess the risk associated with lending money, influencing loan approval and interest rates.

The process begins even before you receive the funds, with the initial application. Over time, your payment habits and the management of the loan balance will continue to influence your credit standing. Additionally, the presence of a personal loan can contribute to the diversity and overall length of your credit history.

Initial Credit Impact from Application

Applying for a personal loan typically involves a “hard inquiry” on your credit report. A hard inquiry can cause a small, temporary dip in your credit score. This minor reduction usually resolves within a few months, and the inquiry itself remains on your credit report for up to two years.

The effect of multiple hard inquiries is mitigated for certain types of loans, including personal loans, when consumers are “rate shopping.” Inquiries made for the same type of installment loan within a specific timeframe are often treated as a single event. For FICO scores, this shopping period can range from 14 to 45 days, depending on the scoring model version used by the lender. VantageScore models generally consolidate inquiries within a 14-day rolling window. To minimize any potential negative impact, it is advisable to complete all loan applications within a 14-day period, ensuring that multiple inquiries are grouped and counted as one for scoring purposes.

Effect of Payment Behavior

Payment history holds the most significant weight in credit scoring models, accounting for approximately 35% of your FICO Score and around 40% of your VantageScore. Making timely payments on a personal loan can substantially enhance your credit score. Consistent adherence to the loan’s repayment schedule builds a positive payment record, which is a primary indicator for lenders of your ability to manage future debts.

Conversely, late or missed payments can severely damage your credit score. A payment reported as 30, 60, or 90 or more days past due will negatively impact your score, with the severity increasing with the delinquency period. Such negative marks can remain on your credit report for up to seven years. Defaults or the loan going to collections carry even more severe consequences, significantly lowering your score.

Influence of Loan Amount and Utilization

The “amounts owed” category is another significant factor in credit scoring, typically representing about 30% of your FICO Score and between 20% and 30% for VantageScore models. When you initially take out a personal loan, it increases your total outstanding debt, which can affect this category. However, installment loans like personal loans are viewed differently than revolving credit, such as credit cards.

With a personal loan, you borrow a fixed amount and steadily reduce the principal balance with each payment. As you consistently pay down the loan, the outstanding balance decreases, which can positively influence your credit utilization over time. Unlike revolving credit where a high credit utilization ratio (amount owed versus available credit) can negatively impact scores, installment loan balances are primarily assessed based on the initial debt and the consistent progress in repayment. While the total debt load is a consideration, the structured repayment of an installment loan provides a clear path to debt reduction, which is viewed favorably by credit scoring models. Maintaining low balances across all credit accounts, including personal loans, can help optimize this credit scoring factor.

Role of Credit History and Mix

A personal loan also plays a part in two other components of your credit score: the length of your credit history and your credit mix. The length of credit history typically accounts for about 15% of your FICO Score and between 15% and 21% for VantageScore models. When you open a new personal loan, it adds a new, relatively young account to your credit report.

This new account can slightly decrease the average age of all your credit accounts, particularly if you have a short overall credit history. However, this effect is usually minor and diminishes as the personal loan ages. As you make consistent payments over the loan’s term, the account matures, eventually contributing positively to the length of your credit history.

The credit mix component, which makes up about 10% of your FICO Score and between 10% and 21% for VantageScore models, evaluates the diversity of your credit accounts. If your credit profile primarily consists of revolving credit, such as credit cards, adding an installment loan like a personal loan can diversify your credit portfolio.