How Does a Personal Loan Affect Your Credit Score

One of the major concerns people have when considering taking out a personal loan is how it will affect their credit score. A personal loan can impact your credit in a number of ways, providing both long-term advantages with some short-term downsides. When taking out a personal loan, here are some ways a personal loan may affect your credit score.

What is a Personal Loan, and When Should You Consider One?

To understand how a personal loan can impact your credit situation, let’s first understand what a personal loan is and when you should consider using one.

A personal loan is money borrowed from a lender that typically provides short- to moderate-term repayment options that can help you afford a more significant purchase or consolidate high interest rates. Unlike home and auto loans, specific to home and car purchases, personal loans can be used for various reasons and circumstances.

For example, common uses for personal loans include financing a large purchase, debt consolidation, refinancing student loans, financing a wedding, vacation, or other life events, or to improve credit.

Personal loans have no collateral, which means they are unsecured and supported by the borrower’s creditworthiness rather than collateral like property or other assets. For this reason, they tend to be viewed as having a higher risk for the lender, and therefore, come with higher interest rates. However, secured personal loan options exist and can help provide you with funds immediately and improve your credit score.

What Do You Need to Qualify for a Personal Loan?

As with most financing options, the greater your credit score, the more likely you will be approved for a personal loan and receive more favorable rates and terms. While every lender utilizes different credit scoring criteria, borrowers with good credit and above will generally qualify for personal loans.

How a Personal Loan May Affect Your Credit Score

Whether you wish to tackle credit card debt by consolidating payments into one monthly payment with a lower interest rate; refinance student loans to secure a lower interest rate; or need to finance a big purchase and want to avoid using a line of credit, revolving credit, or putting it on a high-interest credit card—using a personal loan to pay for bigger items may be a viable option for you.

Negative Impacts

When you first take out a personal loan, you may experience some initial negative impacts on your credit. Here’s what you can expect.

Ding Your Credit Score

It’s likely your credit score will take a small hit since you’re acquiring more debt. As you make on-time payments over time, you can easily build your credit back up. However, if you fail to make payments on time or default on the loan entirely, this can have more severe ramifications for your credit score.

Challenge to Borrow More

In the short-term, taking out a personal loan may prohibit you from getting another loan or opening more credit cards without hurting your credit score.

Additionally, it may be harder to obtain additional credit cards or loans before the loan is paid off. This is because credit bureaus monitor new credit activity. If you try to secure a new car loan shortly after taking out a personal loan, for example, you could be rejected because you already have too much debt.

Positive Impacts

By making full, on-time payments and demonstrating that you are responsible with debt, a personal loan might improve your credit score. Here’s how.

Improve Credit Mix

A factor in having a strong FICO score or other credit score is having a healthy mix of types of credit. If your credit report reveals that you mostly have credit card debt, a personal loan can contribute to a more robust credit account mix and improve your score even further.

Strengthen Credit History

Like car loans or other borrowing types, making your personal loan payments on time can help enhance your credit history and raise your credit score. The simplest way to ensure a personal loan doesn’t lower your credit score is to pay the amounts owed on time and within the loan agreement’s terms and conditions.

Lower Credit Utilization Ratio

A personal loan may also help lower your credit utilization ratio, which is the amount of credit you’re using compared to your credit limit. Taking out a personal loan can increase the total amount of credit available to you, and the less that you use, the higher your credit score will be.

Personal Loan Affect Your Credit Score

The Bottom Line

Taking out a personal loan can impact your credit score in a handful of ways. While it may affect your score initially and make it a bit more challenging to access new credit before the loan is paid off, your personal loan may help you improve your credit situation in the long run.

By responsibly making payments on your personal loan in a timely fashion, you can boost your credit score by improving your credit mix, strengthening your credit history, and lowering your credit utilization ratio. Before you take out a personal loan, it’s always best to consult a financial advisor and weigh your options to determine what type of financing is best for you and your situation.

If you’re ready to secure a personal loan today, you can apply online with T&I Credit Union and hear back within as little as one business day. Call us at (248) 397-9571 to apply.

About Tammy Newcomb

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