If you’re considering a personal loan, you might wonder what kind of impact it may have on your credit. It’s true that the application process can cause your credit score to dip temporarily, but a loan can potentially help it too.
We’ll run through all the ways a personal loan can affect your credit score, as well as when you might consider a personal loan for your financial life.
How Is Your Credit Score Calculated?
To understand how a personal loan can affect your credit, it helps to know the basics of how your credit score is calculated. According to FICO®, a company that generates credit scores, five principal components are used to calculate your FICO Score:
• Payment History (35%): Your history of making on-time payments to lenders is a key factor, accounting for more than a third of your score.
• Amounts Owed (30%): The amount of credit you are currently using is the second-most important factor.
• Length of Credit History (15%): The length of time you’ve had credit accounts open, and in good standing, is also a factor. Opening new lines of credit will bring down the average age of your credit history.
• New Credit (10%): This component considers the amount of new credit recently taken out.
• Credit Mix (10%): This final factor takes into account the different types of credit you hold: credit cards, personal loans, mortgages, etc.
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How Do Personal Loans Work?
A personal loan is a borrowed sum of money that is paid back in installments, with interest. Loan amounts typically range from $5K to $100K.
Common uses for personal loans include consolidating high-interest credit card debt, and funding large purchases such as home improvements, weddings, unexpected medical expenses, moving expenses, and funerals.
Recommended: Types of Personal Loans
Do Personal Loans Hurt Your Credit?
Any debts you have can impact your credit, so taking out a personal loan might lead to a drop in your credit score over the short term. On the flip side, there are ways for your personal loan to positively affect your credit score.
Here’s how a personal loan can impact your credit score, negatively or positively:
• Can add to your credit mix
• Could improve your payment history if you pay on time
• May help keep your credit utilization ratio in check
• No collateral required
• Requires a hard credit inquiry
• May increase amounts owed
• Could negatively impact your payment history if you miss payments
• Fees can drive up the cost of the loan
Con: Requires a hard credit inquiry
Taking out a loan often requires a hard credit inquiry, which can adversely impact your credit score. Hard inquiries remain on your credit report for two years, though their negative effect on your score is minor (typically 5 points or less) and lasts only a year.
Con: May increase amounts owed
The “amounts owed” on your credit score may increase because you are taking on new debt. However, if you’re consolidating credit card debt, you will reduce that debt by paying it down with the personal loan — your amount owed doesn’t change.
Con: Can impact your payment history if you miss a payment
If you miss a payment on your personal loan, that can negatively impact the “payment history” component of your credit score. That factor specifically looks at whether you make your debt payments on time.
Con: Some lenders charge fees
Fees can drive up the cost of a loan, beyond what you’re paying in interest. For example, an origination fee, which lenders charge upfront, is typically a percentage of the principal. And prepayment penalties discourage borrowers from paying off their loan early. (SoFi never charges any fees.)
Pro: Can add to your credit mix
Having a new loan type (and paying it back on-time) can positively impact the “new credit” and “credit mix” components of your score.
Pro: Can improve your payment history if you pay on time
Making on-time payments and showing responsible management of a personal loan is a nice checkmark for the “payment history” part of your credit score.
Pro: May help you keep your credit utilization ratio in check
If you’re using a personal loan to reduce credit card debt, it replaces revolving debt (your credit card debt) with an installment loan. Revolving debt is one you can continue adding to even when paying it down. An installment loan involves borrowing one specific amount and repaying it in — wait for it — installments. Because you won’t be able to add further debt to your installment loan, it may help you keep your credit utilization ratio under control, which can be a good thing for your credit score.
Pro: No collateral required
Loans can be either secured or unsecured. A secured loan is one that requires the borrower to put up collateral, such as a car or home. An unsecured loan requires no collateral.
When To Consider Taking Out a Personal Loan
There’s not a clearcut answer to whether a personal loan can hurt your credit, because everyone’s financial situation is different. But here are some instances when a personal loan may be appropriate:
• You’re consolidating high-interest debt
• You have an emergency expense you can’t otherwise afford
• You’re paying for a home improvement project that will add value to your home
• It’s your least expensive borrowing option
• You don’t have any collateral to offer
Before you take on any debt, it’s always important to consider whether it’s really necessary and what other ways you might cover your costs. For instance, it’s often not recommended to take out a personal loan to pay for a vacation when you can scale back on your travel plans or simply wait until you’ve saved up enough money. It’s obviously a very different story if you have to cover the cost of a medical emergency.
Consider whether you can afford to make the payments on time. And make sure you understand the total cost of the loan, with interest and any fees added in. Also think about whether your credit score is high enough to qualify for competitive rates and terms, and whether it can withstand any dips applying for a loan might cause.
Recommended: How To Get Approved for a Personal Loan
Applying for a personal loan requires a hard credit inquiry, which typically dings your credit score by around 5 points. But overall, as long as you don’t borrow more than you can pay back, and you make all scheduled payments on time, a personal loan can have a positive impact on your credit score over the long term. A personal loan can add to your credit mix, and will improve your available credit if you’re using it to pay off high-interest credit cards.
Shop around for the best personal loan offers for you. SoFi’s personal loan calculator can show you what your monthly payment might be in different scenarios. SoFi can give you a rate quote in minutes.
Is a personal loan bad for your credit?
There’s no clearcut answer because personal loans can have a positive or negative impact on your credit score. The loan itself has less of an impact than how you manage your loan. If you never miss a payment, a personal loan can help your credit score over time. But if you can’t afford to make your monthly payments on time, that can hurt your score.
Will a personal loan affect my credit card application?
It can. If you applied for the loan recently, you may want to wait and see how your credit score is affected before applying for a credit card. A personal loan can have a positive or negative impact on your credit score, depending on your financial situation and how you manage the loan.
Will a personal loan affect my car loan application?
It can. A personal loan affects your “credit utilization,” which impacts your credit score. How much impact it has depends on your financial situation. If the personal loan is your only debt, for instance, your credit utilization might be able to accommodate both loans.
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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.