Personal loans are an excellent option for consolidating debt, paying off credit cards, or even funding a significant event. However, the idea of a loan being helpful can sound a little contradictory. Though they can be beneficial, it is important to note that personal loans require a credit check like any other type of credit. This does not mean that the personal loan can affect your credit score but the application process. In addition, the long-term effects of the personal loan really depend on how you manage the payments of the loan, specifically if you miss payments.
Does applying for a personal loan affect your credit scores?
Like all other loans, the application process for a personal loan requires a hard inquiry. Hard inquiries impact your credit, making your score drop a few points. This can be daunting initially, but hard inquiries typically fall off in a few months or a year. Hard inquiries are a part of credit and your credit score, so it is not too concerning. However, they become an issue when you have too many hard inquiries in a short time frame. So ultimately, applying for a personal loan can affect your credit score. Still, it might not be as bad as you think with the proper precautions.
Do personal loans build credit?
Personal loans can help build your credit as long as you are financially responsible. Particularly because how you manage your payments is reported to the credit bureaus monthly. There are some ways that you can make sure your personal loan is helping and not hurting your credit because it could go either way.
How a personal loan can help your credit
A personal loan can make a positive impact on your credit overall. To provide a positive effect, you want to make sure you take these steps:
If you make on-time payments
Make sure your payments are paid on time every month. Some creditors offer a discount on your interest rate for setting up autopay. This means you would have the monthly payment automatically taken out of a checking or savings account and paid directly to the creditor. If you are confident you will have the amount ready each month by the due date, autopay removes the thought and any extra stress and saves you some money. If you do not feel comfortable with autopay, you can stick with the traditional way of making payments. However, it is easy to miss a date or overlook a payment. So you can also set a monthly reminder to make sure you make your payment on time or early every month.
Lower credit utilization rate
Using a personal loan to consolidate credit card debt can help lower your credit utilization. Credit cards are considered revolving credit meaning the balance can vary each month which factors into your credit score. Using a personal loan to pay off your revolving credit lowers your credit utilization rate because that debt is now tied to a set monthly payment.
Boost credit mix
Personal loans are a different type of credit than credit cards, a more commonly used form of credit. Having other forms of credit in your credit mix can boost your score because creditors see managing multiple forms of credit as less risky.
How a personal loan can hurt your credit
Personal loans are a form of credit, so they do run the risk of harming your credit. Like any form of debt, there are considerations during the application process and the term of the loan that can be risky.
Increase debt
When applying for a personal loan, you want to consider that this could be an additional monthly payment if you are not using it to consolidate debt. You have the advantage of having a set payment every month, but you want to ensure you do not take on more than you can handle. Additionally, suppose the loan is taken out to consolidate credit card debt. In that case, you want to make sure you stay out of that credit card debt, at the very least, until the loan is paid off.
Hard inquiry
A personal loan will add another hard inquiry to your credit. It is essential to keep this in mind if you have been applying for a lot of credit; you can see a more considerable drop in your score. Fortunately, if you prepare correctly and don’t have a lot of inquiries on your credit, the decrease in your score will not be too drastic.
Missing a payment
Missing a loan payment can have some negative consequences on your credit. You can incur a hefty fee for missing a payment and hurt your credit score. Be sure to make your payment as soon as you remember. A missed payment typically does not significantly impact your credit until after 30 days.
Limit your personal loan’s negative credit impact
A personal loan can be helpful if you diligently limit its negative impact. For example, ensure that you make your payments on time, stay on top of your credit reports, and only use your personal loan funds for things you need. Minimizing the negative impact will make your overall loan experience less stressful and more effective. You might even notice that the personal loan has helped your credit score.
Personal loans can be good
A personal loan does not have to hurt your credit score or be a negative experience. For example, suppose you are diligent, aware of your finances, and stick to the primary use for the loan. In that case, the overall experience can be pleasant and help your financial future. You may even notice that the personal loan helped build your credit score.
FAQ
How do loans affect your credit score?
Loans can drop your credit score temporarily but you can see some improvement if you are using it to consolidate debt.
Does applying for a loan affect credit?
Applying for a loan is a hard inquiry and does affect your credit.
Does a personal loan show up on a credit report?
A personal loan will show up on your credit score because it is a line of credit. It could also show up negatively if you miss a payment.
