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How Will A Personal Loan Affect My Credit Score

A personal loan can be beneficial in a number of different ways. People often take out personal loans to help lower their credit card debts, make a large purchase, invest in renovations or even just to pay for a vacation.

But if you’re thinking about taking out a personal loan – no matter what you’re using it for – you should consider how it might affect your credit score.

Factors That Determine Your Credit Score

There are five main factors that credit bureaus use to determine your credit score. Each factor contributes to your score differently:

  1. Your payment history accounts for 35% of your score
  2. Your debt accounts for 30%
  3. The length of your credit history accounts for 15%
  4. New credit accounts for 10%
  5. Your credit mix accounts for 10%

How Will A Personal Loan Affect Your Credit Score?

The way a personal loan affects your credit score depends in large part on your specific credit history. Depending on how these five factors affect your credit score, a personal loan could either hurt your credit or help to improve your credit.

How a Personal Loan Can Hurt Your Credit Score

Simply applying for a personal loan is going to slightly ding your credit. This is because the lender will perform a credit inquiry. Credit inquiries tend to decrease your credit a little bit, although they shouldn’t affect your score by that much.

Typically speaking, a credit inquiry for a personal loan shouldn’t drop your credit score by more than five points. However, if you’ve applied for multiple loans or lines of credit within a short period of time, those credit inquiries may add up and do more damage.

Speaking of applying for multiple lines of credit within a short period of time, one of the factors that can hurt your credit is the age of your credit. If the majority of your credit is new, it can hurt your credit score.

If you’ve recently applied for other loans or credit cards, then you might want to think twice about taking out a personal loan on top of that, especially if you’re not applying for a loan out of financial necessity.

The credit inquiries and the addition of new credit to your credit profile aren’t the only ways a personal loan can end up hurting your credit score; if you’re not financially responsible, a personal loan can do a lot of damage.

If you already have a lot of debt that you’re paying off – and you’re not using your personal loan to consolidate those debts – then adding more debt is only going to hurt your credit, especially when considering the fact that debt accounts for 30% of your overall score.

Secondly, if you miss any payments or consistently make late payments on your personal loan, it’s also going to do quite a bit of damage. Your payment history accounts for 35% of your credit score, after all.

Additionally, late or missed payments leave serious blemishes on your credit history that lenders will take note of in the future. If you can’t afford to make payments, then you shouldn’t be taking out a personal loan.

How a Personal Loan Can Help Your Credit Score

When looking at the how a personal loan could hurt your credit score, you might be a little bit wary about taking out a personal loan. But, if you don’t have a lot of new credit and you’re financially responsible (meaning you don’t have a lot of debt and you tend to make payments in full and on time), then a personal loan shouldn’t hurt your credit other than the initial credit inquiry.

In fact, it can help to improve your credit over time. The following are a few ways in which taking out a personal loan can help to actually boost your credit score:

  • Free up credit – Personal loans are considered installment loans, which don’t affect your credit score as much as revolving credit. By using a personal loan to pay off your credit card debt, you can improve your utilization ratio (which is the balance you owe versus the total credit you have), which can help to improve your credit score.
  • Improve your credit mix – Having a mix of different types of credit makes your credit profile look better. This means that if you only have credit available from credit cards, taking out a personal loan can help improve your mix, which does account for 10% of your credit score and can help to improve it.
  • Reduce your debts faster – Personal loans don’t typically have as high of an interest rate as credit cards. Additionally, they come with terms that require you to pay them off within a certain period of time. This means that by consolidating your credit card debt using a personal loan, you could end up reducing your debt faster, thereby improving your credit score sooner.
  • Bolster your payment history – By taking out a personal loan, you’ll have to make payments every month. Making your payments on time and in full will only help to boost your credit score by strengthening your payment history.
  • Add to your credit history – Having no credit is almost as bad as having poor credit. If you don’t have much credit to your name, then taking out a personal loan can help to establish credit history, which will help improve your credit score and make it easier to take out lines of credit in the future.

If your credit history is already in bad shape and you’re not careful with your finances, then taking out a personal loan could hurt your credit score.

However, if you’re financially responsible, a personal loan can truly help your credit score –and your wallet – in many ways.

Find out how you can apply for a personal loan by contacting us at Al-Gar Federal Credit Union today or apply online today.