How Much Does a Personal Loan Affect Credit Score?
Learn how a personal loan impacts your credit score over time, from initial inquiry to full repayment, and the key factors involved.
A personal loan provides a borrower with a lump sum of money, repaid over a set period through regular, fixed installments, typically with interest. Unlike mortgages or auto loans, most personal loans are unsecured, meaning they do not require collateral. A credit score serves as a three-digit numerical summary of an individual’s creditworthiness. Lenders use this score to assess the likelihood of timely loan repayment, influencing both eligibility and the terms of borrowing, including interest rates.
Immediate Credit Score Changes
When applying for a personal loan, the initial impact on a credit score involves a slight, temporary dip. This occurs due to a “hard inquiry” on your credit report, conducted by lenders to evaluate creditworthiness. A single hard inquiry lowers a FICO score by fewer than five points. Its effect generally lasts for up to 12 months, though it remains on the credit report for two years. Multiple hard inquiries within a short period, aside from specific rate-shopping for mortgages or auto loans, can signal higher risk to lenders, potentially leading to a more pronounced negative impact.
Opening a new credit account, such as a personal loan, also contributes to this initial score adjustment. Adding a new loan can decrease the average age of credit accounts, a factor in credit scoring models. This effect is more noticeable for individuals with a shorter credit history, as the new account represents a larger proportion of their total credit timeline. This initial dip is short-lived, with scores rebounding within a few months, assuming responsible credit management.
Credit Score Changes During Repayment
The most significant influence of a personal loan on a credit score occurs during repayment. Consistently making on-time payments is the most impactful factor, as payment history accounts for 35% of a FICO score. Each timely payment demonstrates responsible financial behavior, building a positive credit history and supporting score improvement. Conversely, a single payment 30 days or more past due can severely damage a credit score and remain on the credit report for seven years.
As the loan balance decreases with each installment payment, this positively reflects on the “amounts owed” category, which constitutes 30% of a FICO score. Although personal loans are installment credit and do not directly affect credit utilization ratios like revolving credit, paying down this debt is viewed favorably by scoring models. Introducing an installment loan can diversify a borrower’s credit mix, especially if their credit profile primarily consists of revolving accounts. Credit mix accounts for 10% of a FICO score. Demonstrating the ability to manage different types of credit responsibly can contribute to score enhancement.
Credit Score Changes After Repayment
Once a personal loan is fully paid off, its positive influence on a credit score continues for a considerable period. An account with on-time payments remains on a credit report for up to 10 years after it is closed. This extended presence ensures positive payment history continues to contribute to the overall credit profile. The length of credit history, which considers account age, also benefits from the paid-off loan’s longevity.
The “new account” factor no longer applies, but the established record of responsible repayment reinforces creditworthiness. This ongoing positive data helps maintain or improve the credit score over time. Complete repayment of an installment loan signifies a successful debt management cycle, a strong indicator of financial reliability.
Factors Influencing the Impact
A personal loan’s impact on a credit score is influenced by several variables. A borrower’s credit health prior to the loan plays a significant role; someone with an excellent credit score might experience a smaller, more transient dip from a hard inquiry compared to an individual with limited credit history. Lenders also consider overall credit history and existing debt levels when assessing new applications.
The loan’s size relative to income and existing debt also influences perceived risk and impact. High balances across credit accounts can negatively affect a score, though merely owing money does not automatically lower it. Lenders evaluate a borrower’s debt-to-income ratio, which, though not directly part of credit score calculations, impacts loan eligibility and terms.
Most personal loans are unsecured, meaning they are not backed by collateral. Both secured and unsecured loans trigger similar credit checks and payment reporting. However, unsecured loans often demand higher credit scores for approval due to increased risk for lenders. Responsible loan management, regardless of type, remains the primary factor in its long-term credit score impact.