How Does a Personal Loan Affect Your Credit Score?

A personal loan has the ability to help and hurt your credit score. When used responsibly, a personal loan can help you build credit and show that you can responsibly borrow money. However, if you overextend yourself or miss your payments, you'll see your credit score drop.

Here's how to maintain your credit score while paying off your loan.

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How a Personal Loan Can Help Your Credit Score

A personal loan can greatly help your credit score in a few key ways. It can:

• Help you to build your record of on-time payments — this is the single weightiest element of your credit score.

• Improve your credit mix — if you've only got one or two types of credit, for example. credit cards and a mortgage, your credit score will benefit from opening a new account type, like a personal loan.

• Reduce your credit utilization if you're using your loan to pay down credit card debt.

Responsibly using your loan can help take your credit score to the next level.

How a Personal Loan Can Hurt Your Credit Score

Alternatively, irresponsibly using a personal loan can wreck your credit score. For example:

• Failing to make your monthly payment will result in a credit score free fall. Missing payments is one of the worst things you can do for your financial wellbeing.

• If you use your personal loan as debt consolidation to pay off credit cards but then immediately rack up debt on those cards again, you'll find yourself paying overwhelming monthly interest rates that may not be sustainable without drastic measures like bankruptcy.

• Your debt-to-income ratio may increase.

Of course, just the act of applying for a personal loan will temporarily drop your credit score by a few points. We'll discuss this in a minute.

Short-Term vs. Long-Term Credit Score Impact

In the short term, your credit score is bound to dip a little bit when you apply for a personal loan. When a bank takes a look at your creditworthiness, it performs a hard credit inquiry on your credit report. This dings your score slightly.

With responsible use, though, your credit score should be back and better than ever in a month or two. The positive long-term effects of opening a personal loan can far outweigh the short-term negative ones — as long as you use it responsibly.

Again, if you do absolutely nothing else, be sure to make your monthly minimum payment. Not only will a missed payment drop your credit score, but it can result in penalties and increased interest rates.

Should You Get a Personal Loan to Build Credit?

Even if you're brand new to credit, there are credit-building personal loans designed to jumpstart your journey into the credit world. That said, these aren't generally recommended — you'll end up paying monthly interest just for the privilege of building a credit history.

Best Practices for Managing a Personal Loan

Here are the best ways to manage a personal loan:

Make Every Payment on Time

Late payments are like a dagger to your credit's heart. Collections will stay on your credit report for seven years, so it's wise to set your loan to autopay — just in case you forget.

Don't Take Out More Than You Need

Only request as much money as you can pay back. It's easy to spend money when it's just sitting there gathering cobwebs.

Monitor Your Credit Regularly

If something goes awry, such as a late payment or some sort of fraud, you can spot it quickly by keeping an eye on your credit.

Avoid Taking Multiple Loans at Once

In addition to the extra headache of juggling multiple personal loans simultaneously, opening more than one loan at a time can be bad for your credit. Your debt-to-income ratio may be higher, you'll be spending more money in monthly payments and your score will be dinged for numerous hard credit inquiries.

Alternatives That Can Also Build Credit

You don't have to resort to a personal loan to fortify your credit profile. There are other simpler ways to do it, such as:

• Secured credit cards: These are best for beginners. You'll provide a security deposit when you open account and your credit limit will match that. Be sure to pay on time and keep your balance low.

• Become an authorized user: The credit history of whichever card you're added will appear on your credit profile — meaning you could soon have an excellent credit score even without a loan of your own.

• Using rent or utility reporting services: Some programs, like Self or Experian Boost, allow you to claim practices like on-time rent or utility payments as on-time payments so you can improve your score.

If you're ready to start loan shopping, here are the best personal loans for people with good credit.

FAQs

Will my credit score drop when I apply?

When you apply for a personal loan, your credit score will temporarily drop — but just slightly. Every time you apply for a loan, be it a credit card, personal loan, auto loan, etc., your credit will sustain a hard credit pull. This drops your credit for a month or two, but it'll bounce back with healthy credit habits.

How long does it take to see a credit score boost?

Depending on the state of your credit score, you could see a credit score boost as quickly as one month. For example, if you're just beginning your credit journey, you could generate a good credit score in six months. But if you've got a poor credit score because of you've missed payments in the past, it could take a year before any positive activity begins to pay off in a meaningful way.

What happens if I miss a payment?

If you miss a payment, there may be a penalty charge added on. You might see your APR increase as well. Generally, you'll have about a month to bring your account current again before a lender will report your delinquency to the credit bureaus — which wrecks your credit score.

Does paying off a loan early hurt my credit?

Paying off a long early isn't a bad thing at all. However, it hurt your credit score in a way. That's because once a personal loan is paid off, the account is closed. Closing an account can injure your length of credit history.

Can a personal loan replace credit card debt to raise my score?

A personal loan can be used to pay off your credit card debt. If you take out a personal loan to consolidate balances, your credit score may skyrocket from a lower credit utilization.

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