Personal loans can affect your credit score for the personal loans—better or worse. When you apply for a personal loan, you’re not borrowing against any credit you have, so you don’t lose any of your available credit when you apply. However, there are plenty of other factors that go along with borrowing a new debt that could negatively impact your overall credit score down the road if you’re not careful—so it’s likely wise to stay away from applying for multiple personal loans at once and to instead choose the best personal loan for which you think you’ll qualify and only apply once.
Let’s explore how personal loans can affect your credit score and what you can do to manage this impact effectively.
Basics of Credit Score
Before we look at how personal loans can affect your credit scores, let’s first take a step back and know what exactly credit score is.
Your credit score is only a number that indicates your credit worthiness on scale of 300-900, the higher scores means good credit.
Credit scores are calculated based on five key factors:
- History of the payment (35%): The record of your paying bills on time.
- Credit Utilization (30%): This is the amount of credit you’re using compared with your credit limits.
- Length of Credit History (15%): Average age of your credit accounts.
- This is about the various types of credit you have including credit cards, mortgages and personal loans.
- New Credit (10%): Recent credit inquiries and newly opened accounts.
How Applying for a Personal Loan Impacts Your Credit Score
Applying for a personal loan does cause a small temporary dip in your credit score. This happens because lenders do a hard credit check on your credit report to determine how likely you are to repay the borrowed money, and each hard inquiry lowers your score by just a little bit.
If you’re already juggling debt, taking on new loan can cause your credit score to take a slight dip in the beginning. But if you have a long history of managing debt well and making payments on time, this impact is usually small and short-lived.
You will want to be strategic about when you apply for new loan. Personal Loan Apply in 2024 right after you apply for a credit card can result in multiple hard inquiries within a short time frame which could drop your credit score by quite a bit.
An overview of how a personal loan can affect Credit Scores both Positively and Negatively
Below is a table showing how a personal loan can affect your credit score.
| Effect | Positive Impact | Negative Impact |
| Diversifying Your Credit Mix | – Adding a personal loan can be an asset to your credit mix (i.e. revolving credit, such as credit cards and installment credit, like a personal loans). – A mix of credit accounts can help your credit score, because credit scoring models like to see that you can manage different types of credit, such as revolving and installment accounts, responsibly. | – If your credit mix already includes several installment loans, adding another may have a minimal impact or could even be seen as overextension by lenders. |
| Establishing a Positive Payment History | – Paying your personal loan on time helps your payment history, which is the most important factor in your credit score. – Every on-time payment helps build your record of responsible credit use and can improve your credit score over time. | – Missing or making late payments can significantly harm your credit score. – Payment history makes up 35% of your credit score- so even one late payment can really cause a significant dip in your score. |
| Lowering Credit Utilization Ratio | – Taking a personal loan to pay down high-interest debt on your credit cards can reduce the ratio of credit you are using (the amount of revolving credit you use compared to your total available credit). – Your credit score will go up as long as your utilization ratio is lower. | – However, if personal loan doesn’t meet your entire debt or if you still continue to accumulate credit card debt then it means your overall debt load is increasing which will affect your credit history negatively. |
| Hard Inquiries | – The effect of hard inquiries on your credit score is generally minimal, and they typically only appear on your report for about two years. – Over time, your score may recover, and even improve, as you manage new credit responsibly. | – Each time you apply for personal loan online, lenders perform a hard inquiry on your credit report, which can lower your credit score temporarily. – Multiple inquiries in a short period can have a more significant negative effect. |
| Increased Debt Load | – Managing a higher debt load responsibly can actually show lenders you are capable of managing more credit, and improve your score in the long run. | – Adding a personal loan increases your total debt load, which may lower your credit score, particularly if your debt-to-income ratio becomes too high. – Excessive debt can signal to lenders that you are a higher risk borrower. |
What Credit Score Is Needed for a Personal Loan?
Each FICO score falls into one of five categories: poor, fair, good, very good, and exceptional. Here’s a breakdown of the ranges:
- Poor (<580): Below average, and lenders will consider you a risky borrower.
- Fair (580–669): Below average, but lenders may still approve loans in this range.
- Good (670–739): Near or slightly above average, and most lenders consider this score to be good.
- Very Good (740–799): Above average and indicates to lenders that you are an extremely dependable borrower.
- Exceptional (800+): Well above average, and lenders will view you as an exceptional borrower.
Managing Your Personal Loan for Optimal Credit Health
1. Make Payments on Time
The first and foremost to thing to do when you take a personal loan is to make sure that you pay your EMIs on time. You can either set up auto payments for your personal loan or add a reminder in your mobile phone so that you don’t miss the EMI ever. Making regular and timely payments does not only help in building your payment history but also keeps improving your credit score steadily.
2. Avoid Taking on Unnecessary Debt
As much as you’d like to, don’t use a personal loan for fun purchases. Borrow only what you need and what you can afford to repay comfortably because adding unnecessary debt will only increase your financial obligations and the potential to harm your credit score. Make sure you can make the payments on time before deciding to borrow.
3. Monitor Your Credit Report
Make it as a routine to check your credit report periodically just to make sure that all the information provided are accurate and current. In addition, you can actually monitor your credit report regularly since by doing so you will always detect errors or any indication of identity theft that might affect your credit score in future. Annually request for one free copy of your credit report from the three major credit bureaus- (Equifax, Experian, TransUnion).
4. Use Personal Loans for Debt Consolidation Wisely
If you’re taking out a personal loan to consolidate debt, don’t make the mistake of racking up new debt on your credit cards after you pay them off with the loan. Otherwise, you’ll have a cycle of borrowing—and more borrowing that could leave you in worse shape financially. Instead, create a budget and be sure to stick to it so you can manage your spending and stay out of debt again.
5. Communicate with Your Lender
Should you feel that paying off your loan may be a tough thing to do, approach your lender sooner rather than later. There are some lenders who offer hardship programs or who can help restructure the manner in which you pay back the loan. Being proactive about potential problems can keep you from later going into default and ruining your credit report immediately.
Final Words!
Personal Loans are helpful when you know how to use them. They help you in improving your financial health & fulfil your needs. Thus, find the best deal with interest rates & timely repayments. This will help you maintain a good credit score & get better interest rates for future use. If you’re thinking of availing a Personal Loan or making a career as a DSA Loan Agent, Ruloans is here to help you with our expertise & strong network being one of the best loan distributors in India. As a Personal Loan DSA partner, we offer valuable resources for loan agents near you. Join us at Ruloans and take confident steps toward your financial aspirations today.
