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How do personal loans affect your credit score?
It all comes down to whether you make repayments on time.
Done right, a personal loan can be an asset to your credit profile, especially if your credit report is mostly based on credit card debt. Establishing a record of on-time repayments and diversifying the type of credit you have both earn you points. But missing repayments will cause your credit score to take a hit.
How can a personal loan affect my credit score?
A personal loan can both improve and hurt your credit score, depending on whether you make repayments on time.
How it can improve your credit
Taking out a personal loan can improve your credit in three ways:
- Adds to your positive credit history. Paying back a personal loan on time lengthens your history of making on-time repayments. This accounts for 35% of your credit score.
- Lengthens credit history. If you aren’t currently paying off any debts, having a personal loan can add time to your credit history. Length counts for 15% of your credit score.
- Diversifies your credit accounts. A personal loan can improve your score if you have no installment loans on your credit report. Credit diversity accounts for 10% of your credit score.
How it can hurt your credit
A personal loan can also have a negative effect on your credit score in two ways:
- Establishes a negative credit history. The flip side of that credit history portion of your credit score is if you’re late on a repayment or default, your score will take a hit.
- Counts as a credit inquiry. Most lenders conduct a hard credit check when you apply for a loan, which can cause your credit score to dip. New credit inquiries account for 10% of your credit score.
When does a personal loan affect my credit?
A personal loan can have an impact on your credit score as soon as you start looking for a lender to the day you make your final repayment.
Here are four times when it can affect your credit:
- When you compare and apply for personal loans
- When you make on-time repayments
- When you miss a repayment
- When you refinance or consolidate
Comparing and applying for personal loans
- Hurt your credit score
In some cases, checking the rates and terms on a personal loan involves a hard credit check, which hurts that new credit portion of your credit score. Most lenders conduct a hard credit check when you submit your application.
This drop in your credit score generally only lasts a few months, but can spell less favorable rates and terms if you decide to apply with another lender.
How can I avoid this?
While it’s hard to avoid at least one credit inquiry, there are two ways to minimize the impact of your application. First, prequalify with lenders that offer a risk-free quote based on a soft credit check. If that’s not an option, try to submit applications within the same 30-day period — most credit bureaus see this as rate-shopping and only count it as one credit inquiry.
Repaying a personal loan on time
- Improves your credit score
Making on-time repayments generally has the largest positive impact on your credit score. That’s because repayments make up the largest percentage of your credit score than any other factor. It also lengthens your history of on-time repayments, which is the third most important factor contributing to your credit score.
Is signing up for autopay good for my credit?
It depends on how closely your monitor your bank account. Autopay is designed to ensure your repayments go through on time if you always have enough money in your account.
But you could accidentally miss a repayment if you move money around and forget that your loan payment is due — or otherwise have a cashflow problem. You can avoid this by remembering your due date and being mindful of your account balance.
Missing a repayment
- Hurts your credit score
Missing even one repayment can have a negative impact on your credit score if you miss your lender’s grace period. Most lenders allow around 15 days before they report late repayments, so you have some breathing room. But once it hits that 15-day mark, your credit score will drop and you’ll also likely be charged a late fee.
How can I avoid this?
Contact your lender if you think you’re going to be late on a repayment before it’s due. It might be willing to adjust your terms or move your due date so you can keep your record clean.
Consolidating debt or refinancing a personal loan
- Improves your credit score
Consolidating debt can have a similar impact on your credit as taking out a new personal loan. It can give you lower rates and terms that better fit your budget.
If you have credit card debt, it can also help you lower your credit utilization ratio by getting you on schedule to make headway on your balance. Just keep that credit account open since closing credit cards lowers the amount of credit available to you.
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Should I take out a personal loan to build my credit?
Generally no. While taking out a personal loan might offer an opportunity to build your credit, it’s difficult to qualify for competitive rates and terms if you don’t already have an established positive credit history. Instead, you might want to use products that are designed to help improve your credit, like a credit-builder loan or secured credit card.
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Bottom line
A personal loan can have an overall positive impact on your credit score if you pay it off on time. But it can lower your score if you miss a repayment or go into default. You can learn more about how they work with our guide to personal loans.
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