Applying for a personal loan can affect your credit score – in a bad way at first, but ultimately for the better, assuming you handle the loan responsibly.
When you first apply for a loan, your credit score will temporarily fall by a small amount. That’s because one of the factors that affects your score is how often you apply for credit, and a new loan will weigh that down.
But in the long run, making regular, on-time payments is the best way to boost your credit score permanently.
In this article, we’ll go through all the ways applying for a personal loan can affect your credit score and help you make the right financial decisions.
Written by Joseph Widenhofer ContributorJoseph Widenhofer is a freelance copywriter and editor focusing on economic development, personal finance, schools and boards of developmental disabilities. He primarily works for the Golden Shovel Agency, a full-service virtual agency, as a short- and long-form content writer, as well as a website copywriter tasked with showcasing the positive impact of Economic Development Organizations and how they improve the lives of everyone in their community.
When he’s not writing, Joseph is going on adventures with his wife and dog, reading sci-fi and fantasy novels, listening to investing podcasts and regularly exercising. Connect with him on LinkedIn .
Edited by David Gregory EditorDavid Gregory is an editor with more than a decade of experience in the financial services industry. Before that, he worked as a child and family therapist until he made the decision to move abroad for several years to work and travel.
Our Research Process Edited by David Gregory EditorDavid Gregory is an editor with more than a decade of experience in the financial services industry. Before that, he worked as a child and family therapist until he made the decision to move abroad for several years to work and travel.
Why Trust UsHere’s a breakdown of how we reviewed and rated top personal loan providers
33 Providers RatedOur team researched more than two dozen of the country’s most popular personal lenders, including large online companies like SoFi, big banks like Wells Fargo, and peer-to-peer lenders like Upstart.
660 Data Points AnalyzedTo create our rating system, we analyzed each personal loan company’s disclosures, licensing documents, marketing materials, sample loan agreements and websites to understand their loan offerings and terms.
41 Loan Features TrackedOur team regularly collects data on each company’s loan offerings and terms, such as minimum and maximum loan amounts, origination fees and discounts.
17 Professionals ConsultedBefore we began our research process, we consulted with financial advisors and industry experts to ensure our evaluations covered the banking product aspects that matter most to potential customers.
Related ResourcesYes, applying for a loan initially hurts your credit, though only by a small amount. That’s because you undergo a credit inquiry as part of the application process.
A credit inquiry is a request from a lender or another entity to review your credit report. Lenders do this to assess your creditworthiness when you apply for a loan, credit card or mortgage. There are two types of inquiries: hard and soft inquiries. These have very different impacts to your credit score.
Soft inquiries, on the other hand, are typically not related to a credit application. They can result from checking your credit report, pre-approved offers or background checks. Soft inquiries do not affect your credit score. In many cases, lenders will offer to prequalify you for a loan using only a soft credit score. When you actually apply for the loan, though, there’s no getting around a hard inquiry.
Hard inquiries occur when you formally apply for credit, such as a personal loan or credit card, by the lender. Your credit score is one of many things lenders will evaluate in their approval process. These types of inquiries are visible on your credit report and can have a temporary negative impact on your credit score. This drop occurs because it suggests you’re actively seeking new credit, which may pose a risk.
Multiple hard inquiries may occur if you apply for several loans or credit cards quickly. While each inquiry can impact your score, credit scoring models often treat multiple inquiries for the same type of credit within a specific timeframe as a single inquiry to minimize their impact.
The impact of hard inquiries on your credit score diminishes over time, and they typically remain on your credit report for two years. Continue to manage your existing credit responsibly, and your score will recover.
One way personal loans can affect your credit is through multiple loan applications within a short period. When you apply for a personal loan, the lender performs a hard inquiry on your credit report. If you submit numerous applications quickly, these hard inquiries can accumulate, signaling to lenders that you might seek more credit than you can handle.
Multiple hard inquiries can raise concerns for lenders. They may perceive you as a higher credit risk, potentially leading to unfavorable loan terms or even loan denials.
Another way personal loans can harm your credit is by defaulting or making late payments on them.
Personal loans, like other credit accounts, are reported to credit bureaus such as Experian, TransUnion and Equifax. Negative information concerning your loan, such as late payments, defaults or accounts sent to collections, can significantly lower your credit score. This negative information typically remains on your credit report for several years, which means its impact can linger even after you’ve resolved the issue.
>> Related: Learn more about loan default
But personal loans can be a powerful tool for building credit, too, when used responsibly. Successfully managing your personal loan payments can be one of the most effective ways to boost your creditworthiness.
The foundation of building good credit with a personal loan is consistently making on-time payments. Payment history is one of the most significant factors affecting your credit score. Late payments or defaults can have a detrimental impact on your credit score, so it’s essential to prioritize timely payments.
On-time payments demonstrate your ability to manage credit responsibly and are a crucial factor in your credit score. This track record can open doors to better credit opportunities in the future.
Personal loans can also help improve your credit utilization ratio, the amount of credit you use compared to your total credit limit. As you pay down your personal loan, your credit utilization decreases, positively impacting your credit score.
A diverse credit portfolio, including installment loans like personal loans, can improve credit scores as well. Credit scoring models consider your various types of credit accounts, such as credit cards, mortgages and installment loans. Having a mix of credit types demonstrates your ability to manage different types of credit responsibly.
Before diving into personal loans, take a moment to assess whether you genuinely need one. Personal loans can be a lifeline during emergencies or for essential expenses. Evaluate your situation and ensure the loan is necessary for things like medical bills or home repairs. If you’re considering a personal loan for debt consolidation, calculate whether it will save you money in the long run by reducing interest rates and simplifying your payments.
Personal loans are just one of many financial tools available. It’s essential to explore alternative options before committing to a loan. If you have savings, consider using them for unexpected expenses instead of taking out a loan. An emergency fund can provide a financial safety net.
Credit cards with low interest rates or promotional balance transfer offers may be a cost-effective way to cover your needs. Sometimes, borrowing from family or friends might be an option, but ensure there are clear terms and open communication to avoid potential conflicts.
Selecting the right lender is crucial to ensure a positive borrowing experience and protect yourself from scams. Do thorough research on potential lenders. Look for reviews, ratings and the lender’s history to gauge their reputation. Ensure that the lender is licensed and compliant with state regulations. Avoid lenders with a history of unethical practices.
Don’t rush into a loan agreement. Compare loan terms, interest rates and fees from multiple lenders to find the best deal for your individual needs.
Reading and comprehending the loan terms is essential once you decide to apply for a personal loan. Make sure you understand the interest rate and whether it’s fixed or variable. Be aware of any application fees, origination fees or prepayment penalties associated with the loan. Review the repayment schedule to ensure it aligns with your financial situation. Know your monthly payment amount and due date.
Personal loans are a financial tool that can help you achieve various goals. When you apply for a personal loan, the lender conducts a credit inquiry, which can temporarily decrease your credit score. Multiple loan applications within a short time frame can raise concerns for lenders and potentially affect your creditworthiness.
Personal loans can positively impact your credit when managed responsibly. Making on-time payments is crucial for building a positive credit history and improving your credit score. A mix of credit types, including installment and personal loans, can contribute to a better credit profile.
Defaulting or making late payments on personal loans can have serious consequences, including a negative impact on your credit score and potential legal actions by the lender. Understanding your loan terms, interest rates and fees is vital to avoid unexpected financial challenges.
When used wisely, personal loans can be a valuable financial tool, but they require responsible management. Whether you’re considering a loan or already have one, be informed, make thoughtful decisions and manage your credit responsibly. By doing so, you can harness the potential benefits of personal loans while minimizing their potential risks and help ensure a healthier financial future.
Loans have the potential to improve your credit when managed responsibly. Making on-time payments and checking your credit utilization are critical factors in building a positive credit history. A mix of credit types, including installment and personal loans, can contribute to a healthier credit profile.
Paying off a loan early can be a positive financial move. It can save you money on interest and free up your budget for other financial goals. However, checking your loan agreement for any prepayment penalties that might apply is essential.
You can explore options like banks, credit unions, online lenders or peer-to-peer lending platforms. To find the right lender, compare interest rates, fees and terms from various sources and choose one that offers favorable terms and a good reputation.
The maximum loan amount you can get from a bank varies widely depending on several factors, including your creditworthiness, income and the bank’s policies. Banks typically offer more significant loan amounts compared to other lenders, but the specific limit will vary from bank to bank.
Editor’s Note: Before making significant financial decisions, consider reviewing your options with someone you trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.
If you have feedback or questions about this article, please email the MarketWatch Guides team at editors@marketwatchguides. com.