If you’re considering a personal loan, you might be wondering, “Does a personal loan hurt your credit?” The answer is, it depends. Personal loans can hurt your credit score, but they could potentially help it too.
We’ll talk you through how 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?
In order to understand how taking out a personal loan can affect your credit, it can help to know the basics of how your credit score is calculated in the first place. According to FICO®, a company that generates credit score profiles, there are five principal components used to calculate your FICO Score and each are weighted by importance:
Payment History (35%): Your history of making on-time payments to lenders is a key factor in your credit score, accounting for 35% of your score.
Amounts Owed (30%): The amount of your total credit you are currently using is the second-most important factor in your credit score.
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 factor takes into consideration 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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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 could be ways for your personal loan to positively affect your credit score. Here’s how a personal loan could negatively — and positively — impact your credit score:
• 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
• Requires a hard credit inquiry
• May increase amounts owed
• Could negatively impact your payment history if you miss payments
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 they will only negatively affect your score for a year, and usually not severely.
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 may reduce that debt by paying it down with a personal loan.)
Con: Could impact your payment history if you miss a payment
If you were to miss a payment on your personal loan, that could negatively impact the “payment history” component of your credit score, which specifically looks at whether you make your debt payments on time.
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 credit score.
Pro: Could improve your payment history if you pay on time
Making on-time payments and showing your 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 a revolving debt (your credit card debt) with an installment loan (a personal loan). Revolving debt is a debt you can continue adding to even when paying it down, whereas 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 could be a good thing for your credit score.
When to Consider Taking Out a Personal Loan
Given there’s not a clearcut answer to whether a personal loan can hurt your credit, you may still be wondering whether or not you should take one out. Here are some instances when it may be appropriate to consider taking out a personal loan:
• You’re consolidating high-interest debt
• You have an emergency expense you can’t otherwise afford
• You’re doing 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 whether there are any other ways to cover your costs. For instance, it’s often not recommended to take out a personal loan to pay for a vacation when you could 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.
You will also want to consider whether you can afford to make the payments on time and ensure you understand the total cost of the loan with interest and any fees added in. Also take into consideration whether your credit score is high enough to qualify for competitive rates and terms, as well as whether it can withstand any dips applying for a loan might cause.
As long as you don’t borrow more than you can pay back and make all scheduled payments on time, a personal loan may have a positive impact on your credit score over the long term. But there’s no one-size-fits-all answer to how a personal loan will impact your credit — it really depends. What is certain is that having a stellar credit score can open doors for you, as you’re more likely to get better financing offers in the future.
If you think your credit score can weather taking out a personal loan, it’s important to shop around for the best offers. SoFi can give you a rate quote in minutes.
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
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