Will a personal loan help or hurt my credit score?

June 23, 2022

By Lois Sullivan

Will a personal loan help or hurt my credit score?

Will a personal loan help or hurt my credit score?

A personal loan could help or hurt your credit, depending on your actions. Personal loans are very versatile, and you can use them for almost anything. You can pay for emergency expenses, consolidate debt, make improvements to your home, and more. However, before applying for any personal loan, you should check that the lender doesn’t impose any restrictions for business use. Before you apply for a personal loan, it's a good idea to understand your credit score and how a personal loan could affect it.

Your credit score

Most lenders consider your credit score and credit history before deciding on the rates and terms for a personal loan or another kind of loan. Three credit bureaus in the United States, Experian, Equifax, and TransUnion, record credit scores and credit reports about potential borrowers. Lenders usually divide credit scores into these categories:

  • 300 to 629 –  poor
  • 630 to 689 – average or fair
  • 690 to 719 – good
  • 720 to 850 – excellent

Your credit score is calculated from your credit history, and you can get detailed copies of your credit reports from the credit bureaus. The credit bureaus use slightly different methods to calculate credit scores, but they all base about the same percentages of their scores on these criteria:

  • 35% payment history
  • 30% total amount of outstanding debt or debt-to-income ratio
  • 15% length of credit history
  • 10% new debt or lines of credit
  • 10% credit mix or the number of loans and lines of credit that someone has

Understanding your credit score lets you predict the interest rate you'll get for a personal loan and compare offers from different companies. For more detailed information, you can check your credit reports. If you notice any errors or inaccurate information, you can raise your credit score by disputing it. Learning more about your credit history also makes improving your credit score easier.

Do personal loans hurt your credit?

In some circumstances, a personal loan could hurt your credit. When you apply for a personal loan, the lender usually performs a hard inquiry on your credit report. A hard inquiry could temporarily reduce your credit score by a few points. Instead of applying for several loans, consider getting prequalified. When you prequalify for a personal loan, the lender often performs a soft credit check that doesn't change your credit score.

You won't get a guaranteed rate until you complete an application, but prequalifying lets you get an estimate of your rate and monthly payments for which you may qualify for. That way, you can compare different loans without having to lower your credit score by applying for them all. When you're ready to apply for your first choices, keep your applications within one or two weeks of each other to minimize the impact on your credit score.

Do personal loans help your credit score?

When you use it in a smart way, a personal loan can help your credit score.

Even when you get a personal loan for home improvements, a fun vacation, or another expense, you can use it to improve your credit score by making your payments on time. This act helps build your payment history, which is 35% of your credit score. It demonstrates to lenders that you can honor your responsibilities and pay for your debts.

However, if you have a low credit score or a short credit history when you apply for a personal loan, you may need to pay a higher interest rate. While your credit score may drop slightly right after you apply for a personal loan, it could rise as you make your payments on time.  

Getting a personal loan can also raise your credit score by improving your credit mix or the variety of credit accounts you have. These accounts can include mortgages, credit cards, lines of credit, vehicle loans, home equity loans, and other forms of credit. Having a good credit mix and a good payment history shows lenders that you can handle many different forms of debt. Your credit mix is worth about 10% of your credit score.

Even though you may see credit score improvements in the examples above, you should never take out a loan for the sole purpose of raising your credit score.

Applying for a personal loan

When you apply for a personal loan, be prepared to provide copies of several documents. People often provide a driver's license, passport, or another form of government-issued identification, recent tax returns, and pay stubs. Lenders often ask for copies of utility bills as proof of your address. They may want to know why you want to get a loan, how much you want to borrow, and how quickly you want to make payments. Being able to provide more documentation could help you get a lower interest rate.

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