Do Personal Loans Hurt Your Credit? What You Should Know

Personal loans can temporarily lower your credit score by a few points because applying usually triggers a hard inquiry and adds a new account to your credit report. Over time, however, making consistent on-time payments may help improve your credit score, while missed payments can significantly damage it.

Here's when a personal loan may affect your credit and what you can do to protect your score.

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How Personal Loans Affect Your Credit Score

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

A 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 can then impact 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 a few 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. Having different types of credit accounts can strengthen your credit mix, so adding a personal loan may help improve your score over time.

• 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 can strengthen your credit profile. However, late payments can have the opposite effect, with each delayed payment weighing your score down.

When Personal Loans Hurt Your Credit

A personal loan can hurt your credit score when you first apply or if you have trouble keeping up with payments. Here are three ways it can negatively affect your credit:

• Hard inquiry: When you formally apply for a personal loan, the lender typically performs a hard credit check. This may temporarily lower your score by a few points.

• New account: Opening a personal loan lowers the average age of your credit accounts, which can cause a temporary dip in your score.

• Increased debt: Taking on a personal loan adds to your outstanding debt. If you're already carrying large balances, the additional debt could negatively affect your credit profile.

Late Payments: How Bad Is the Damage?

Missing a personal loan payment can have a much bigger impact on your credit than applying for the loan itself.

A payment that's 30 or more days late may be reported to the credit bureaus and significantly lower your score. Late payments can remain on your credit report for up to seven years, although their impact lessens over time.

Recovering from a missed payment depends on your overall credit history and how late the payment was. Making future payments on time and avoiding additional missed payments can help you rebuild your credit, but improvements may take months or longer.

Short-Term vs. Long-Term Effects

In the short term, your credit score may dip slightly when you take out a personal loan due to the hard inquiry performed during your application. Over time, making consistent on-time payments may help your score recover.

Here's a general timeline of what to expect:

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

• Months four 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.

• Years one to three: With consistent on-time payments, a personal loan may help strengthen your credit profile. You'll have more positive payment history, and the hard inquiry generally stops affecting your FICO score after one year. Once the loan is paid off, how loan payoff affects your credit may be the next question to consider.

Pro Tip

Making consistent, on-time payments can help offset the initial credit ding of opening a personal loan. However, improvements depend on your overall credit profile.

5 Factors That Determine Impact on Your Credit

Before getting into the details, it helps to understand how personal loans and your credit score are connected. 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 amount owed. If you’re already carrying lots of debt, adding a new loan could decrease 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: Consistent on-time payments can help strengthen your credit score over time. 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 may help 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.

Good To Know

If you’re considering using a personal loan to consolidate debt, make sure you understand how the move could affect your credit.

When a Personal Loan Can Help Your Credit Score

When used strategically, a personal loan can be a tool for building a stronger credit profile, but the benefits depend on your starting point and how you manage the loan.

• If your credit report only has credit cards: Then adding an installment loan diversifies your credit mix, which may provide a modest boost.

• If you carry high credit card balances: Then using a personal loan to pay them off can lower your revolving utilization ratio, which may improve your score, even though your total debt stays the same.

• If you need to build or rebuild payment history: Then a personal loan gives you a multi-year runway of monthly payments to demonstrate reliability, which may help you build credit.

Important: These benefits aren't guaranteed. Results vary based on your overall credit profile, existing debt load and whether you consistently make on-time payments. A personal loan is a tool, not a shortcut.

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:

• 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.

• Prequalify before applying: Many lenders offer prequalification with a soft credit check, letting you preview estimated rates and terms without hurting your score. With prequalification, you can compare rates and terms before committing to a full application and hard inquiry.

• 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.

• 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.

• 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.

Key Terms

• Hard credit inquiry: A formal credit check triggered when you apply for a loan or credit card. Hard inquiries can lower your FICO score by a few points and typically remain on your report for two years, though their impact fades after a few months.

• Credit utilization ratio: The percentage of your available revolving credit currently in use. Using a personal loan to pay down credit card balances can lower this ratio and improve your score.

• Credit mix: The variety of credit account types on your report, such as credit cards, auto loans and installment loans. It accounts for about 10% of your FICO score, and adding a personal loan can diversify it.

• Payment history: The record of whether you have paid your bills on time. It is the single largest factor in your FICO score at 35%, making consistent on-time payments the most impactful thing you can do for your credit.

• Prequalification: A soft credit check that lets you preview estimated loan rates and terms without affecting your score. It allows you to compare multiple lenders before formally applying and triggering a hard inquiry.

Sources

• MyFICO. "How to Rate Shop and Minimize the Impact to Your FICO Scores."

• MyFICO. "The Timing of Hard Credit Inquiries."

Parts of this article were created with AI assistance. MoneyLion editors reviewed, fact-checked and edited the final version and are responsible for its accuracy.