Will Taking Out a Loan Hurt Your Credit Score?

A credit score serves as a numerical representation of an individual’s creditworthiness, ranging from 300 to 850 or 900. Lenders, insurance companies, and even landlords use this score to assess the likelihood of an applicant repaying debts and fulfilling financial obligations. This three-digit number is compiled by major credit reporting agencies such as Equifax, Experian, and TransUnion, reflecting a person’s history of managing credit accounts.

How Applying for a Loan Affects Your Score

When you apply for a loan, lenders typically perform a “hard inquiry” on your credit report. A hard inquiry is recorded on your credit report and can cause a small, temporary dip in your credit score, usually by five points or fewer for most individuals.

This minor score reduction generally lasts for a short period, often impacting your score for up to one year, although the inquiry itself may remain on your report for two years. The exact impact can vary based on your overall credit history; someone with a longer, more established credit profile might see a smaller effect than someone with a limited history.

For specific types of loans, such as auto loans or mortgages, credit scoring models often treat multiple inquiries made within a short timeframe as a single inquiry. This “rate shopping” window typically ranges from 14 to 45 days. However, this grouping usually does not apply to different types of loans, meaning applying for a car loan and a personal loan simultaneously could result in two separate inquiries.

The Ongoing Influence of Active Loans on Your Score

Once a loan is active, its ongoing management significantly shapes your credit score. The most impactful factor is payment history, which accounts for approximately 35% of a FICO score. Consistent, on-time payments demonstrate financial reliability and contribute positively to your score over time. Conversely, even a single payment that is 30 days or more late can severely damage your credit score, and these negative marks can remain on your credit report for up to seven years.

The amounts owed on installment loans also play a role, distinct from how revolving credit is assessed. For installment loans like mortgages, auto loans, or personal loans, scoring models consider the original loan amount versus the remaining principal balance. As you consistently make payments and reduce the principal, this decreasing balance is viewed favorably, signaling responsible debt management. This differs from revolving credit where a high utilization of available credit can negatively affect your score.

The length of your credit history also influences your score, typically making up about 15% of a FICO score. An older average age of accounts and a longer history of responsible credit use are generally beneficial, as they show a sustained ability to manage debt. Opening a new loan account can slightly reduce the average age of your accounts, but the long-term benefit of a well-managed, older account outweighs this initial minor impact.

Furthermore, your credit mix, which constitutes about 10% of a FICO score, considers the diversity of your credit accounts. Having a healthy blend of different credit types, such as installment loans and revolving credit accounts, can positively impact your score. This demonstrates your ability to responsibly manage various financial products, showcasing a broader financial competency to lenders.

Understanding Different Loan Categories and Their Credit Implications

Different loan categories are structured uniquely, which impacts how they affect your credit score. The primary distinction lies between installment loans and revolving credit. Installment loans, such as mortgages, car loans, student loans, and personal loans, involve borrowing a fixed sum of money that is repaid over a set period through regular, typically equal, monthly payments. Once the loan is fully repaid, the account is closed.

In contrast, revolving credit, such as credit cards, offers a line of credit that can be used repeatedly up to a certain limit. Payments are based on the outstanding balance, which can fluctuate, and the account remains open as long as it’s active.

A key factor for revolving credit is the credit utilization ratio, which is the amount of credit used compared to the total available credit. While both installment and revolving accounts contribute to your payment history and credit mix, their structural differences lead to varied impacts on the “amounts owed” portion of your score.

Loans can also be categorized as secured or unsecured. Secured loans require collateral, like a car for an auto loan or a home for a mortgage, which the lender can seize if payments are not made. Unsecured loans, such as personal loans or credit cards, do not require collateral and are issued based solely on your creditworthiness. Both types of loans are reported to credit bureaus and affect your score similarly through payment history, although defaulting on a secured loan carries the additional risk of losing the pledged asset.