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Depending on your situation, applying for a personal loan can actually improve your credit. However, to reap the rewards, you need to make all of your monthly payments religiously and monitor your credit report, or your credit score could be negatively affected.
Find out how personal loans can affect your credit score.
Learn More: What Is a Personal Loan?
How personal loans can help or hurt your credit score
Having a good score can help you qualify for lower interest rates and save money over time.
Learning how to build credit is essential. Credit bureaus determine your score using five key pieces of data:
- Payment history
- Amount of money owed
- Length of credit history
- New credit
- Credit mix
When you take out a personal loan, that debt can affect all five areas, causing your score to increase or decrease in the following ways.
- Establishing payment history
- Lowering your credit utilization ratio
- Improving your credit mix
- Introducing new credit
- Adding new credit inquiries
1. Establishing payment history
Credit impact: Helps your credit
Your payment history is the single biggest factor in determining your credit, accounting for 35% of your credit score. If you make all of your personal loan payments on time by the statement due date, you’ll have a positive payment history and your score can go up.
By contrast, missing even just one payment on your loan can damage your payment history and cause your score to go down. Continue making all of your payments on time, and avoid late payments, so you don’t fall behind.
2. Lowering your credit utilization ratio
Credit impact: Helps your credit
Your credit utilization — or how much of your available credit you’ve used — accounts for 30% of your credit score. If you regularly max out your credit cards, your credit utilization is likely quite high, damaging your credit. You can improve your score by taking out a personal loan for debt consolidation.
Personal loans are installment loans, so they’re not considered in the credit utilization ratio. But using a low-interest personal loan to pay off your high-interest credit card debt is a smart way to lower your ratio and boost your credit.
3. Improving your credit mix
Credit impact: Helps your credit
Lenders like to see that you can responsibly handle several different types of credit, such as credit cards, student loans, personal loans, auto loans, and more. Your credit mix determines 10% of your credit score. If you take out a new personal loan, you diversify your credit mix which can improve your credit.
Learn More: How Debt Consolidation Helps Your Credit
4. Introducing new credit
Credit impact: Can hurt your credit
Lenders get nervous when they see borrowers open new lines of credit in a short period of time. That’s why new credit affects 10% of your credit score. When you take out a new personal loan, it will show up as a fresh account on your credit report and can cause your score to go down slightly.
5. Adding new credit inquiries
Credit impact: Can hurt your credit
When you apply for a personal loan, it’s a good idea to compare offers from different lenders to get the best personal loan rates. However, to offer you a quote, most lenders will perform a hard credit inquiry, which can damage your credit. Credit inquiries can take up to five points off your credit score.
To minimize the impact of credit inquiries when shopping for a personal loan, get quotes at one time using a soft credit inquiry. Comparing personal loan lenders through Credible uses a soft credit check only — and this won’t affect your credit.
Finding a personal loan
Whether you have good credit or bad credit, you can weigh the pros and cons of taking out a loan and its impact on your credit. By making on-time payments, improving your credit mix, and lowering your credit utilization ratio, you can enjoy the benefits of a personal loan while improving your credit.
If you decide that a personal loan is right for you, make sure you compare several different personal loan lenders, including loan terms, loan amount, rates, and more. Credible allows you to compare the best personal loans at once, helping you get the best loan for your situation.
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