How Personal Loans Affect Your Credit Score

A personal loan can affect your credit score in a number of ways⁠—both good and bad. Taking out a personal loan isn't bad for your credit score in and of itself. However, it may affect your overall score for the short term and make it more difficult for you to obtain additional credit before that new loan is paid back.

On the other hand, paying off a personal loan in a timely manner should boost your overall score. If you decide to take one out, be sure to research and compare all of your options thoroughly to qualify for the best possible loan, even if you have bad credit.

How Applying for Loans Affects Your Credit Score

Your credit score is calculated based on five factors: payment history, amounts owed, length of credit history, new credit, and credit mix.

The exact percentages vary among the three major credit rating agencies, but according to FICO, 10% is based on any new debt or newly opened lines of credit, and another 10% is based on credit mix—the number of credit lines that you have open (including secured credit cards). As such, obtaining a new personal loan could affect your credit rating. Your outstanding debt total has now increased, and you have acquired new debt.

Credit agencies also take note of new financial activity. If, for example, you tried to apply for an auto loan shortly after taking out a personal loan, your application might be rejected on the basis that you already have as much debt as you can handle.

Your overall credit history has more impact on your credit score than a single new loan. If you have a long history of managing debt and making timely payments, the impact on your credit score from taking out a new loan is likely to be lessened. The easiest and best way to keep a personal loan from lowering your credit score is to make your payments on time and within the terms of the loan agreement.

How Do People Use Personal Loans?

Investopedia commissioned a national survey of 962 U.S. adults between Aug. 14, 2023, to Sept. 15, 2023, who had taken out a personal loan to learn how they used their loan proceeds and how they might use future personal loans. Debt consolidation was the most common reason people borrowed money, followed by home improvement and other large expenditures.

How a Personal Loan Can Boost Your Credit Score

A personal loan that you repay in a timely fashion can have a positive effect on your credit score, as it demonstrates that you can handle debt responsibly.

Unfortunately, those who are the most averse to taking on debt could have lousy credit scores. After all, a person who never acquires debt and pays it off in installments has no payment history.

What Credit Score Is Needed for a Personal Loan?

FICO scores fall into 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 many lenders may still approve loans with this score.
• Good (670–739): Near or slightly above average, and most lenders view this as a good score.
• Very Good (740–799): Above average and shows lenders that you are a very dependable borrower.
• Exceptional (800+): Well above average, and lenders will view you as an exceptional borrower.

The higher your credit score, the more likely a lender is to approve your loan application and offer more favorable terms, such as a lower interest rate. While each has its own criteria, in general, lenders view scores above 670 as an indication that a borrower is creditworthy.

Also keep in mind that while your credit score plays a crucial role in helping you qualify for a personal loan, lenders also consider other factors like the amount of income you earn, how much money you have in the bank, and how long you have been employed.

Finding the right loan can be particularly stressful when you face a financial emergency and need to borrow money in a hurry. If you have the additional obstacle of bad credit, accessing cash quickly may seem even more daunting. Fortunately, you may still be able to secure an emergency loan even when you have credit problems.

Frequently Asked Questions (FAQs)

The Bottom Line

A personal loan will cause a slight hit to your credit score in the short term, but making on-time payments will bring it back up and can help improve your credit in the long run. A personal loan calculator can be a big help when it comes to determining the loan repayment term that's right for you.

Your credit score will be hurt if you pay late or default on the loan. And don't forget that a personal loan may also reduce your borrowing power for other lines of credit. If you've recently taken out a personal loan and accidentally made multiple late payments or defaulted on said loan, one of the best credit repair companies might be able to help remove the negative marks on your credit report.