How Does a Personal Loan Affect Your Credit Score?

Borrowing money usually impacts your credit, but how a personal loan affects your credit score depends on your situation.

Your score may dip in the short term when you apply for a personal loan and your debt increases. But a personal loan can also boost your credit score, so long as you always make your payments on time.

Key takeaways

• A personal loan can improve your credit score if you repay it on time, but it can ding your score in the short term.
• Personal loans could harm your credit score by shortening your credit history, increasing your debt load or causing lenders to think you may be struggling.
• If you’re careful how you shop for loans, you can help keep your credit strong.

How a personal loan can improve your credit score

Over the long term, a personal loan can help you get or keep a good credit score if you pay on time, offsetting any downside to your credit from getting the loan in the first place.

On-time payments can show you have a dependable payment history

Your payment history — how well you’ve handled loans in the past — is the biggest factor in your credit score. A strong record of on-time and complete payments will improve your credit scores with the main credit score agencies.

And if you have very little credit history (or are “credit invisible” with no credit file at all), then borrowing and repaying a personal loan will help you start building that positive payment history and make it easier to get credit in the future.

Consolidating credit card debt can lower your credit utilization ratio

How much available credit you use on your credit cards or other lines of credit is called your credit utilization ratio. Having a high ratio means you’re in danger of maxing out your credit cards, and this will hurt your score.

For a good credit score, you should use 30% or less of your card’s credit limit (and never max it out).

Because personal loans don’t affect your credit utilization ratio, you can lower your ratio by paying off your credit card balance with a debt consolidation personal loan. This can help you raise your credit score, even though your debt will be roughly the same.

It can diversify your credit mix

Lenders like borrowers who can successfully manage different kinds of credit accounts, such as credit cards, mortgages and installment loans. The variety of types you have is known as your credit mix.

While your credit mix makes up a smaller share of your credit score than payment history or utilization, taking out a personal loan could help you add to your mix and improve your score.

How a personal loan can hurt your credit score

Taking on a personal loan can weigh down your credit score if lenders think you have too much debt already or are borrowing because you’re in bad financial shape. It can also ding your score in other ways.

Opening a new account can require a hard credit check

When you apply for a new loan, lenders will take a look at your financial background with a hard credit check or hard inquiry.

A hard credit check can ding your credit score, though usually by a few points, but having lots of hard inquiries and new accounts can drop your credit score more, since it’s a sign you may be in financial distress.

On the other hand, in order to allow borrowers to shop around, credit-scoring models will count several inquiries for the same type of loan as a single one if they all happen within 14 to 45 days, depending on the specific credit score.

You can also limit any harm to your score by prequalifying for a personal loan. This will allow you to check your approval chances and get an estimate of your loan terms without formally applying for a personal loan and getting a hard credit check.

It can shorten your average length of credit history

Your credit score also considers how long you’ve been using your credit, the age of each credit account, and the average age of all your accounts.

Because lenders prefer borrowers with a long, proven track record, having accounts with an older average age can help your credit score. On the other hand, adding a new personal loan will lower your average account age, which could slightly hurt your score.

A new loan could mean more opportunity to miss payments

A personal loan will increase your monthly expenses, so be sure you can afford it. The larger the loan and the higher the interest rate, the more costly the debt will be and the more likely you are to miss a payment.

You can sometimes get away with being up to 30 days late, but once your lender reports your payment as delinquent, your credit score will suffer.

And if you default on your personal loan, the damage can be heavy, with the stain remaining on your credit report for seven years.

Too many new credit accounts can be a red flag

Taking on a lot of new debt in a short space of time will hurt the average age of your credit accounts, as discussed above. For this reason, try to wait a few months to get a personal loan if you’ve recently opened other credit accounts.

But beyond just hurting your credit score, too many new accounts could also make lenders think you may have cash flow issues or other financial problems, making it harder to get approved for new credit.

A new loan will increase how much you owe

The more debt you have, the harder it can be to manage and repay it, which is why your credit score also looks at your total debt owed. If a personal loan adds a lot to the total amount you owe, it could hurt your score.

How to preserve your credit score when borrowing

To limit any harm to your credit score, follow these tips when getting and repaying a personal loan:

• Shop for loans in a short time period, or use an online marketplace like LendingTree: If you rate-shop for a loan within a certain time frame, all applications will be treated as a single hard credit inquiry instead of several different ones. Depending on the credit-scoring model, this shopping window may be as short as 14 days or as long as 45. Or you could use LendingTree’s personal loan marketplace to compare offers from up to five lenders at once.
• Avoid high-interest, predatory loans: Your credit score helps decide the interest rate and repayment terms a lender will offer. If you have bad credit and are struggling to qualify for a loan, you might be tempted by a predatory loan offer with triple-digit rates. These can put a lot of pressure on your budget, making it more likely you’ll miss a payment and tank your credit score.
• Don’t take on more debt than you can handle: Even if you have a loan with a reasonable rate, make sure you don’t borrow more than you can afford to comfortably repay. Just one late payment can harm your score.
• Don’t close old credit cards if you can help it: If you use a personal loan to consolidate your credit card debt, you may be tempted to cancel your now paid-off cards to avoid running up balances on them again. But avoid doing this, so long as you won’t use them and there are no annual fees. This is because credit cards with no or low balances reduce your credit utilization ratio and help maintain a long credit history, which are both important for a good credit score.
• Always make on-time payments: The biggest factor affecting your credit score is your payment history. For an excellent credit score, make complete and on-time payments every month. You can set up autopay to ensure you never accidentally miss a bill.
• Monitor your credit regularly: Incomplete, inaccurate or fraudulent information on your credit report could be damaging your credit score. Review your report to be sure there are no issues, and dispute any problems you find. You can use LendingTree Spring to monitor your credit for free, or you can do it yourself by requesting free copies of your credit report from the three major credit bureaus via annualcreditreport.com.