If I Get a Loan, Will It Affect My Credit?

A credit score is a numerical representation, typically a three-digit number ranging from 300 to 850, that indicates an individual’s credit risk or the likelihood of repaying borrowed money on time. Lenders and creditors use these scores when deciding whether to approve new accounts, and they can also influence the interest rates and terms offered on loans. Credit scores are dynamic, meaning they change over time based on an individual’s financial behaviors and reported credit activity. Understanding how these scores are impacted by financial decisions, such as obtaining a loan, is important for managing personal finance effectively.

Applying for a Loan and Your Credit

When a loan application is submitted, a “hard inquiry” occurs. This happens when a lender requests to review a credit report to assess creditworthiness for a new loan or credit card. This action is recorded on the credit report and can temporarily reduce a credit score. A single hard inquiry might cause a small decrease of less than five to ten points on a FICO Score. Hard inquiries usually remain on a credit report for up to two years, though their influence on credit scores often diminishes after 12 months.

Multiple inquiries for the same type of loan, such as a mortgage or auto loan, within a short period are often grouped and counted as a single inquiry by credit scoring models. This allows consumers to shop for the best rates without penalizing their score for each comparison. This rate-shopping period typically ranges from 14 to 45 days, depending on the credit scoring model used. Opening a new credit account also contributes to the “new credit” category, which accounts for about 10% of a FICO Score. This can slightly lower the average age of all credit accounts, a factor considered in the length of credit history.

Additionally, a new loan increases the total reported debt. While this does not immediately impact the credit utilization ratio like revolving credit, it adds to the overall amount owed. The “amounts owed” category makes up approximately 30% of a FICO Score.

Managing a Loan and Your Credit Score

The most significant factor influencing a credit score after a loan is approved and payments begin is payment history, which accounts for approximately 35% of a FICO Score. Consistently making on-time payments demonstrates responsible financial behavior and contributes positively to a credit score. Conversely, late or missed payments can severely damage a credit score. Payments reported 30 days or more past due are particularly detrimental and can remain on a credit report for an extended period.

As an installment loan’s principal balance decreases with each payment, it positively impacts the “amounts owed” category. While installment loans do not have a revolving credit utilization ratio, the reduction in the outstanding balance indicates a lower debt burden. The proportion of the original loan amount still owed is considered in this category.

The length of credit history is another important element, making up about 15% of a FICO Score. A loan contributes to the average age of all credit accounts and demonstrates a longer history of managing credit successfully. As the loan ages and is managed responsibly, it helps to establish a more mature credit profile.

Different Loan Types and Credit

Loans generally fall into two primary categories: installment loans and revolving credit. Installment loans, such as auto loans, mortgages, or student loans, involve borrowing a fixed sum of money that is repaid in regular, predetermined payments over a set period. Once the loan is paid off, the account is closed. In contrast, revolving credit, like credit cards or lines of credit, allows borrowing up to a certain limit, repaying the balance, and then borrowing again. The amount owed can fluctuate, and there is no fixed end date as long as the account remains open and in good standing.

Having a diverse “credit mix” can positively influence a credit score, accounting for about 10% of a FICO Score. This means demonstrating the ability to responsibly manage both installment loans and revolving credit accounts. Lenders often view a mix of credit types as an indication of a borrower’s experience and capacity to handle various financial obligations.

Loans can also be classified as secured or unsecured. Secured loans require collateral, such as a car for an auto loan or a home for a mortgage, which the lender can seize if the borrower defaults. Unsecured loans, like personal loans or credit cards, do not require collateral and are approved based primarily on an individual’s creditworthiness. The presence or absence of collateral does not directly impact the credit score; however, payment behavior and loan type still apply. Both secured and unsecured loans can positively or negatively affect a credit score depending on repayment consistency.