How Much Does a Personal Loan Affect Your Credit Score?

A personal loan is a type of unsecured installment credit where a fixed amount of money is borrowed from a financial institution and repaid over a set period with regular payments that include interest. Unlike secured loans, personal loans do not require collateral, meaning approval is primarily based on a borrower’s creditworthiness. A credit score is a numerical representation, often a three-digit number between 300 and 850, that indicates an individual’s creditworthiness and the likelihood they will repay borrowed money on time. Both the application for and the subsequent management of a personal loan can influence one’s credit score.

The Initial Impact of Application

When an individual applies for a personal loan, lenders typically perform a “hard inquiry” on their credit report to assess creditworthiness. A hard inquiry occurs when a financial institution checks a consumer’s credit history in response to a credit application. A single hard inquiry usually results in a minor, temporary decrease in a credit score, often by five points or less.

Hard inquiries remain on a credit report for up to two years, though their effect on a credit score typically diminishes after about one year. Multiple hard inquiries within a short timeframe, especially for different types of credit, can have a more significant impact. However, when rate shopping for specific loans like mortgages or auto loans, multiple inquiries within a short period, generally 14 to 45 days, are often counted as a single inquiry by credit scoring models to mitigate this effect.

The Ongoing Impact of Loan Management

The most significant influence a personal loan has on a credit score occurs after approval and throughout its repayment period. Responsible management of the loan can positively affect a score, while mismanagement can lead to negative consequences.

Payment History

Payment history is considered the most impactful factor in credit score calculations, accounting for approximately 35% of a FICO score and up to 41% of a VantageScore. Consistently making on-time payments for a personal loan demonstrates financial reliability and can steadily improve a credit score. Each timely payment reinforces a positive credit pattern.

Conversely, missed or late payments can severely damage a credit score. Payments that are 30 days or more overdue can lead to a significant drop in points. These negative marks can remain on a credit report for up to seven years.

Credit Mix

Adding a personal loan to a credit report can diversify an individual’s credit mix, potentially benefiting their score. Credit mix considers the variety of credit accounts an individual manages, including both revolving credit (like credit cards) and installment loans (like personal loans, auto loans, or mortgages). Demonstrating the ability to responsibly manage different types of credit can be viewed favorably by lenders.

Credit Utilization

Personal loans do not have a credit utilization rate in the same way revolving credit accounts do. Credit utilization refers to the amount of revolving credit currently being used compared to the total available credit. However, a personal loan can indirectly improve credit utilization if it is used for debt consolidation, particularly for high-interest credit card debt. By paying off credit card balances with a personal loan, the credit card utilization ratio decreases, which can positively impact the credit score.

This strategy can also simplify debt management by consolidating multiple payments into a single monthly payment. Taking on a personal loan without reducing existing revolving debt could still affect overall credit health. Use the personal loan strategically to reduce high-utilization revolving accounts rather than simply adding more debt.

Length of Credit History

Opening a new personal loan account can slightly reduce the average age of all credit accounts, as new accounts are factored into the overall calculation. While this might cause a minor, temporary dip in the score, the effect is often less significant for those with an already established long credit history.

The long-term benefit of a new account generally outweighs this initial small reduction. Over time, as the personal loan account ages and is managed responsibly, it contributes positively to the overall length of the credit history.

New Credit

The act of applying for and opening a new personal loan account falls under the “new credit” category, which makes up about 10% of a FICO score. This factor considers the number of recently opened accounts. While a new account can temporarily lower a score due to the hard inquiry, successfully managing a new personal loan demonstrates a borrower’s capacity to handle additional credit.