How Does a Personal Loan Affect Your Credit Score?

Yes, a personal loan can hurt your score at first, but help it later if you use it right.

When used responsibly, a personal loan can help you:

• Build credit

• Show that you can responsibly borrow money

• Adds variety to your credit mix

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.

Key Takeaways

• A personal loan can help your credit score by building your on-time payment history, building up your credit mix and lowering your credit utilization when you use it to pay down credit card debt.

• Missed payments and new debt can hurt your score. Watch out for hard inquiries, as it can dip your credit temporarily, though it will eventually bounce back after a few months.

• Only take a personal loan if you have a clear repayment plan and can automate every payment — skip it if you just want a quick score boost.

Summary generated by AI, verified by MoneyLion editors

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How a Personal Loan Can Help Your Credit Score

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

• Payment history: 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.

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

For example, if your balance is $4,000, and you have a $5,00 limit, that's a high credit utilization of 80%. If you pay $3,000 toward the balance, now it's $1,000 out of $5,000, which is 20%, and a much better outlook.

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:

• Late or missed payments: 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.

• Hard inquiry: A hard inquiry can affect your credit score, up to one year.

• Racking up debt after using: 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.

• New account: A new account can lower your overall credit age.

• Debt-to-income ratio increase: 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.

Short-Term vs. Long-Term Credit Score Impact

Short-Term 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.

Long-Term Impact

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.

Tip: Remember — 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. This checklist can help you decide what's best for you:

Yes if:

• You'd like to consolidate high-interest credit card debt.

• You can stay on top of the payment schedule.

• You're OK with lower your credit utilization.

No if:

• You are currently having trouble with payments.

• You don't have a plan to repay the debt — you could just be adding more without a solid strategy.

• You are only looking for a credit score boost.

4 Best Practices for Managing a Personal Loan

Here are the best ways to manage a personal loan:

1. 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.

2. 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.

3. 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.

4. 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?

Yes, your credit score will drop temporarily when you apply for a personal loan — 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 inquiry. 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?

You could see a credit score boost as quickly as one month, depending on the state of your credit score. 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 loan 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.

Key Terms

• Personal loan: A personal loan is a lump sum of money you borrow from a lender and repay in fixed monthly installments, usually at a fixed interest rate.

• Credit score: A credit score is a three-digit number between 300 and 850 that lenders use to gauge how likely you are to repay borrowed money on time.

• Hard inquiry: A hard inquiry happens when a lender checks your credit report to make a lending decision. It can lower your credit score by a few points and stays on your report for up to two years.

• Credit utilization: Credit utilization is the percentage of your available revolving credit you're currently using. Keeping it below 30% can help your credit score.

• Credit mix: Credit mix refers to the different types of credit accounts you have, such as credit cards, mortgages and personal loans. A varied mix can boost your credit score.

• Debt-to-income ratio: Your debt-to-income ratio compares your total monthly debt payments to your gross monthly income. Lenders use it to decide if you can take on more debt.

Sources

• Consumer Financial Protection Bureau — What is a personal loan?

  https://www.consumerfinance.gov/ask-cfpb/what-is-a-personal-installment-loan-en-1567/

• Consumer Financial Protection Bureau — What is a credit score?

  https://www.consumerfinance.gov/ask-cfpb/what-is-a-credit-score-en-315/

• Consumer Financial Protection Bureau — Hard inquiry vs. soft inquiry

  https://www.consumerfinance.gov/ask-cfpb/whats-the-difference-between-a-credit-inquiry-that-i-authorized-an-inquiry-for-a-promotional-offer-an-account-review-inquiry-and-a-consumer-initiated-inquiry-en-1317/

• MyFICO — What is credit utilization?

  https://www.myfico.com/credit-education/credit-scores/amount-of-debt

• MyFICO — What is credit mix?

  https://www.myfico.com/credit-education/credit-scores/credit-mix

• Consumer Financial Protection Bureau — What is a debt-to-income ratio?

  https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-to-income-ratio-en-1791/

Summary generated by AI, verified by MoneyLion editors

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