Can Personal Loans Affect Your Credit Score?

Your credit score may be impacted by a personal loan in a variety of positive and negative ways. Obtaining a personal loan is not in and of itself detrimental to your credit score. However, it can have a short-term negative impact on your credit score and make it more challenging for you to get new credit before the existing loan is repaid. On the other hand, timely repayment of a personal loan ought to raise your rating. If you decide to take one out, make sure to thoroughly investigate and contrast all of your possibilities in order to be eligible for the finest loan.

KEY TAKEAWAYS

• Your overall credit rating could be lowered temporarily when you take a personal loan because you have acquired additional debt.
• Repaying the loan on time will not only bring your credit score back up, but it can also help build it over time.
• In the short term, you may not be able to get another loan or open another credit card.

What Factors Into Your Credit Score

You must be aware of the scoring methodology in order to comprehend how applying for a personal loan impacts your credit score. The FICO credit score, developed by the Fair Isaac Corporation, is the one that lenders use the most frequently. FICO ratings range from 300 to 850. The five components that make up the credit scores are payment history, debt levels, length of credit history, new credit, and credit mix. Here is a breakdown of the relative importance of each component in the computation, as determined by FICO, but the precise percentages may differ amongst the three major credit rating agencies:

• 35% is based on your payment history
• 30% is based on the total amount of your outstanding debt
• 15% is based on the length of your credit history
• 10% is based on any new debt or newly opened lines of credit
• 10% is based on credit mix—the number of credit lines that you have open (including secured credit cards)

Does Applying for Loans Affect Your Credit Score?

As you can see, applying for a new personal loan could have an impact on your credit score. Your total amount owed has climbed, and you've taken on additional debt. New financial activity is noted by the credit rating agencies. If you applied for a new automobile loan, for instance, soon after taking out a personal loan, your application might be turned down on the grounds that you already have more debt than you can handle. Your credit score is more influenced by your complete credit history than by a single new loan. The effect that a new loan will have on your credit score is probably going to be decreased if you have a long history of managing your debt and making on time payments. Making your payments on time and in accordance with the conditions of your loan agreement is the simplest and most effective strategy to prevent a personal loan from damaging your credit score.

How a Personal Loan Can Boost Your Credit Score

Your credit score might be boosted by a personal loan that you repay on time because it shows that you can manage debt responsibly. Strangely enough, those who are most reluctant to take on debt may also have poor credit. No payment history exists for someone who never incurs debt and pays it off in installments.

What Credit Score Is Needed for a Personal Loan?

As was previously noted, credit scores range from 300 to 850. Your chances of getting a loan approved and receiving better terms, such a reduced interest rate, increase with your credit score. While each lender has their own requirements, in general lenders consider scores above 670 to be a sign of a borrower's creditworthiness. There are five levels of FICO scores: bad, fair, good, very good, and outstanding. The ranges are broken down as follows:

• Poor (<580): Below average and lenders will consider you a risky borrower
• Fair (580–669): Below average, but many lenders may still approve loans with this score
• Good (670–739): Near or slightly above average and most lenders view this as a good score
• Very Good (740–799): Above average and shows lenders that you are a very dependable borrower
• Exceptional (800+): Well above average and lenders will view you as an exceptional borrower

According to Experian, one of the credit scoring companies, the majority of Americans (69%) had good or superior credit scores in 2020. The average credit score, which set a new record, was 710. Also bear in mind that while your credit score is important in determining whether or not you qualify for a personal loan, lenders also take other aspects into account, such as your income, the amount of money you have in the bank, and the length of your employment. When you have an urgent financial need and must borrow money, finding the correct loan might be very stressful. Fast cash access may seem much more difficult if you are also dealing with low credit. Fortunately, even if you have credit issues, you might still be able to get an emergency loan.

Making on-time payments will help your credit score recover after taking out a personal loan, which can help you establish credit. Repaying the debt on time is essential. When choosing the appropriate loan repayment period for you, a personal loan calculator can be a tremendous assistance. If you make late payments or default on the loan, your credit score will suffer. Also keep in mind that a personal loan may lower your ability to obtain other lines of credit. One of the greatest credit restoration agencies might be able to erase the negative entries from your credit report if you recently took out a personal loan and unintentionally made numerous late payments or defaulted on the loan.