Do Personal Loans Hurt Your Credit?

The relationship between a personal loan and credit is a two-way street: your score can go either way depending on how you handle the loan. 

When you first apply, your score will likely dip a few points from the hard inquiry. But consistent, on-time payments can push it higher over time. Miss payments, and it'll probably drop.

This article will break down exactly how personal loans affect your credit and what you can do to come out ahead.

MoneyLion offers a service to help you find personal loan offers. Based on the information you provide, you can get matched with offers for up to $100,000 from our top providers. You can compare rates, terms, and fees from different lenders and choose the best offer for you.

How Personal Loans Affect Your Credit Score

A personal loan can affect your credit score at every stage, from application to payoff. 

Remember, your credit score is a three-digit number that reflects how likely you are to repay borrowed money. The most widely used model, the FICO Score, is calculated using five categories: 

1. Payment history (35%)

2. Amounts owed (30%)

3. Length of credit history (15%)

4. New credit (10%) 

5. Credit mix (10%)

Applying for a personal loan can impact several of these categories, which then impacts your score. Here’s how:

• Hard inquiry: When you formally apply for a personal loan, the lender performs a hard credit inquiry to review your credit report. Each hard inquiry can lower your FICO Score by roughly five points, but this is usually temporary. A hard inquiry is different from a soft inquiry.

• New credit account: Opening a personal loan adds a new account to your credit file, which can improve your credit mix (10% of your score). Lenders like to see that you have access to different types of credit accounts, so adding a new one can make your profile more attractive to lenders, which increases your score.

• Payment history: This is where personal loans have the biggest long-term effect. Since payment history makes up 35% of your score, every on-time payment strengthens your credit profile. However, late payments can have the opposite effect, with each delayed payment weighing your score down.

Short-Term vs. Long-Term Effects

In the short term, expect a small dip in your credit score when you take out a personal loan due to the hard inquiry performed during your application. However, with on-time payments, your score should climb over the next few months. 

Here's a general timeline of what to expect:

• Months 1 to 3: Your score may drop slightly due to the hard inquiry and the new account appearing on your report. This is normal and temporary.

• Months 4 to 12: As long as you're making on-time payments, the hard inquiry's impact fades. Your payment history starts building positive momentum. If you used the loan to pay down credit card balances, your lower utilization rate may already be helping your score recover.

• Year 1 to 3+: With consistent on-time payments, the personal loan becomes a net positive for your credit. You've demonstrated the ability to manage installment debt responsibly, your payment history has strengthened, and the hard inquiry no longer factors into your FICO Score at all.

💡 Pro Tip: The long-term benefit of a well-managed personal loan can far outweigh the initial ding.

Factors That Determine Impact on Your Credit

Taking out a personal loan impacts everyone slightly differently. Several factors determine how much (and in which direction) your score moves:

1. Loan amount relative to existing debt: Adding a personal loan increases your total amounts owed (30% of your score). If you’re already carrying lots of debt, adding a new loan could increase your score.

2. Your credit history before the loan: Someone with a long, established credit history and multiple accounts will likely feel the impact of a new loan less than someone with a thin credit file.

3. Repayment behavior: The more on-time payments you make, the more positively your credit score will react. However, missing even a single payment by 30 days or more can cause a significant drop.

4. Credit utilization: If you have high credit card balances and use a personal loan to pay them down, your credit utilization ratio will drop, which should improve your score.

5. Credit mix: If your credit profile consists entirely of credit cards, adding an installment loan diversifies your credit mix, which can help your score. Credit mix accounts for about 10% of your FICO Score.

How to Protect Your Credit When Taking a Personal Loan

If you’re set on taking out a personal loan, there are a few ways to minimize any negative impact on your credit:

1. Only borrow what you need: It can be tempting to take out the maximum amount that you qualify for, but doing this means you’ll have to make larger payments each month, which raises the risk of falling behind.

2. Prequalify before applying: Many lenders offer prequalification, letting you preview what terms you qualify for without hurting your score. With prequalification, you can compare rates and terms before committing to a full application and hard inquiry.

3. Do your rate shopping within a short window: If you apply for multiple personal loans within a 14 to 45-day period, FICO will treat it as one single application. So if you're comparing offers from several lenders, it’s smart to submit your applications back-to-back.

4. Set up automatic payments: Since payment history is the largest factor in your credit score, automating your payments helps eliminate the risk of accidentally missing a due date.

5. Check your credit before applying: Reviewing your credit report beforehand helps you understand where you stand and spot any errors that could affect your rate or approval odds. You can get a free copy of your report from each of the three major bureaus through AnnualCreditReport.com.

6. Monitor your score regularly: After taking out a loan, keep an eye on your credit to make sure payments are being reported accurately and to track your progress over time.

When a Personal Loan Can Actually Help Your Credit

When used strategically, a personal loan can be a tool for building a stronger credit profile.

Applying for a personal loan helps diversify your credit mix. If you only have credit cards on your report, adding an installment loan shows lenders that you can manage more than one type of credit. Since credit mix makes up 10% of your FICO Score, this can give you a modest but meaningful boost.

A personal loan also gives you the opportunity to build your payment history, the biggest factor in your credit score. Over the life of a two- to five-year loan, you can generate dozens of positive data points that strengthen your credit profile.

Finally, using a personal loan to pay off credit card debt can significantly reduce your utilization ratio. Since personal loans are installment debt and don't factor into your revolving credit utilization, this swap can improve your score even though you still owe the same total amount of money.

Alternatives to Personal Loans

If you need access to cash, personal loans are just one of many options. Here are a few alternatives to consider if you don’t want to take out a personal loan:

• Earned wage access (EWA): Earned wage access platforms, like MoneyLion Instacash®, let you tap into future paychecks to use wages you’ve already earned but haven’t been paid for yet. Instacash® has no interest, credit check or mandatory fees, making it a helpful way to cover minor expenses without taking out a loan.

• Credit cards: If you need to cover a smaller expense, a credit card is one of the easiest ways to pay. Additionally, some cards offer 0% annual percentage rate (APR) introductory periods, giving you extra time to pay off your balance interest-free.

• Home equity loans or lines of credit: If you own a home, borrowing against your equity may offer lower interest rates than a personal loan. The drawback is that your home serves as collateral, so if you can't repay the debt, you risk losing your property.

• Balance transfer credit cards: If you want to consolidate debt, then a balance transfer card may be a smart move. It lets you move existing high-interest debt to a new card with a lower (sometimes 0%) introductory rate.Borrowing from family or friends: This avoids any credit impact entirely since informal loans aren't reported to credit bureaus. However, unpaid debts can strain personal relationships, so it's best to put the terms in writing and stick to a repayment schedule.

A personal loan is likely the best option if you need a larger sum, want a fixed repayment schedule and predictable monthly payments or are specifically looking to build credit through diversified account types.

FAQs

Does applying for multiple personal loans hurt your credit?

Each personal loan application triggers a hard inquiry, which can lower your score by a few points. However, if you apply for multiple personal loans within a 14 to 45-day period, FICO will treat them as one single application.

Will paying off a personal loan early improve or hurt my credit?

It depends on your overall credit profile. Paying off a personal loan early closes the account,  likely reducing your credit mix and lowering the average age of your accounts. However, the financial benefits of eliminating debt and interest payments often outweigh the minor credit impact.

Can missing a single payment have long-term consequences?

Yes. A payment that is 30 or more days late can be reported to the credit bureaus and remain on your credit report for up to seven years.

Does a personal loan show up on a credit report?

Yes. Once a personal loan is funded, the lender reports it to the major credit bureaus (Experian, Equifax and TransUnion) as an installment account. It will appear on your credit report along with your payment history, balance and account status. 

Sources

• MyFico.com – What’s in my Credit Score

• Experian.com – What Affects Your Credit Score

• Experian.com – What is Prequalification?

• Experian.com – How Long Do Hard Inquiries Stay on Your Credit Report

• Annualcreditreport.com – Access Your Credit Report

• CapitalOne.com – Does Paying Off a Personal Loan Early Hurt Your Credit Score

• Transunion.com – How Long Do Late Payments Stay on Your Credit Report