Personal loans and other forms of installment debt can also benefit your credit score in various ways. Let’s take a look at them next.
Building And Improving Your Credit Score
When used correctly, a personal loan can help you build or improve your credit score. A solid history of full, on-time payments will account for roughly 35% of your credit score. By simply staying on top of your monthly payments, you’re paving the way for a good credit history. It’s possible to use a personal loan to build credit, but it isn’t always wise.
Installment debt can go a long way toward making – or breaking – your score. With an installment debt, you make payments every month over a period of months or years. This helps increase the length of your credit history, which lenders can later evaluate.
Diversifying Your Credit Mix
Your credit mix is how many types of accounts you have. These may include credit cards, personal loans, mortgage loans and the like. Lenders prefer to see that you can handle different types of credit – specifically, installment and revolving credit.
A personal loan on your credit report can give you a more diverse credit mix. If the only credit accounts you have open are credit cards, adding a personal loan can give your credit score a boost.
Lowering Your Credit Utilization
A personal loan can also help raise your credit score in an indirect but significant way. If you have a lot of credit card debt, you probably have a pretty high utilization rate. Since credit utilization is such a big factor in determining your credit score, using a personal loan to pay off your credit card debt can significantly increase your score. That’s because installment debt, such as a personal loan, doesn’t factor into your credit utilization ratio.
Whether you should use a personal loan for credit card debt will depend on your financial situation.
Consolidating Your Debt
Using a personal loan for debt consolidation can likewise give your credit score a lift.
Suppose you have several credit cards with a high interest rate and balances so large that you’re having trouble making more than the minimum payments each month. In this situation, it might make sense to seek a personal loan in order to combine and pay off all your credit card debt, trading in multiple high-interest payments for a single monthly payment with a lower interest rate. (A personal loan tends to come with a lower rate than a credit card.)
Keep in mind, however, that this tactic only works if you’re committed to reducing your credit card debt in the long term. If you use a personal loan to pay off your credit cards but later max them out again, you aren’t addressing the root of the issue.
FAQs
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.
How badly does a personal loan hurt your credit? ›
Does a personal loan hurt your credit score? Your credit score can dip a few points when you formally apply for a personal loan, but missed payments can cause a more significant drop. Getting a personal loan will also increase the amount of debt you owe, which is one of the factors that make up your credit score.
How many points will my credit score drop for a personal loan? ›
Hard credit checks temporarily lower your credit score by as much as 10 points. If you have excellent credit, applying for a loan will most likely make your score drop by five points or less.
How many points does a personal loan inquiry affect credit score? ›
How do hard inquiries impact your credit score? A hard credit inquiry could lower your credit score by as much as 10 points, though in many cases, the damage probably won't be that significant. As FICO explains, “For most people, one additional credit inquiry will take less than five points off their FICO Scores.”
Do personal loans look bad to lenders? ›
Yes, getting a personal loan before buying a house can impact your mortgage application. Any debt you have listed on your credit reports can affect your ability to get a mortgage loan.
What is one huge disadvantage of a personal loan? ›
Personal Loan Cons. High interest charges. Personal loan applicants with good credit can expect to qualify for a low APR, but others with poor credit may encounter high rates that can go up to 36%. This rate could end up being higher than financing alternatives, such as home equity loans or 0% APR credit cards.
What credit score do you need to get a $30,000 loan? ›
You will need a credit score of 580 or higher to get a $30,000 personal loan in most cases, along with enough income to afford the monthly bill payments. Other common loan requirements include being at least 18 years old, being a U.S. citizen or a permanent resident, and having a valid bank account.
Does paying off a personal loan early hurt credit? ›
Yes, paying off a personal loan early could temporarily have a negative impact on your credit scores. But any dip in your credit scores will likely be temporary and minor. And it might be worth balancing that risk against the possible benefits of paying off your personal loan early.
What credit score do you need for a 25k personal loan? ›
Requirements for a $25,000 Personal Loan
Typically, a desirable credit score for a $25,000 personal loan is around 670 and above, but some lenders work with those who have scores from 580 and up.
Is a personal loan a good way to pay off debt? ›
A personal loan can help you consolidate your debt into a single, lower-interest loan, which may save you money in the long run. Likewise, if you have multiple credit cards with balances, it can be overwhelming to keep track of them all.
Buy now, pay later (BNPL).
Buy now, pay later services allow you to make a purchase and repay it over time. Typically, the loan is paid off in four interest-free installments. Some BNPL lenders don't require a credit check, while others may perform a soft inquiry that doesn't affect your score.
Is 2 hard inquiries bad? ›
Each hard inquiry can cause your credit score to drop by a few points. There's no such thing as “too many” hard inquiries, but multiple credit inquiries within a short window of time can suggest that you might be a risky borrower.
Can you pay off personal loans early? ›
Most personal loan lenders allow borrowers to pay off their loans early, without prepayment penalties. But before you dip into savings or use an influx of cash to pay off a loan, make sure all your financial bases are covered.
What are the three most common mistakes people make when using a personal loan? ›
5 mistakes to avoid when taking out a personal loan
- You don't do your homework. No one likes homework. ...
- You settle for a high-interest rate. ...
- You ignore your credit score. ...
- You forget to make repayments on time. ...
- You don't consider your budget.
Fees and penalties can be high
Personal loans may come with fees and penalties that can drive up the cost of borrowing. Some loans come with origination fees of 1 percent to 6 percent of the loan amount.
Is it better to go through a bank or lender for personal loan? ›
Higher interest rates and fees: Banks tend to charge higher interest rates and more fees compared to their credit union and online lender counterparts. 12 If you don't qualify for a discount rate, you might end up paying more through a bank than you would with another lender.
Do personal loans fall off credit report? ›
A personal loan can stay on your credit report anywhere from a few years to up to a decade, depending on how you managed your debt. Missed payments may remain on your report for seven years, while bankruptcies and closed accounts that you've paid in full could stay on your report for a decade.
Will a personal loan build credit score? ›
Though they're a form of debt, personal loans can also serve as a tool to build credit. This is because they can contribute to your payment history and credit mix, as well as lower your credit utilization ratio. Collectively, these three factors account for 75 percent of your credit score.
What's worse, a personal loan or credit card debt? ›
Personal loans tend to have lower interest rates than credit cards and are geared toward large, one-time expenses. Taking out a personal loan makes the most sense when you know you can make the monthly payments for the full length of the loan.
