Personal Loans: How Will They Affect My Credit Score?

Personal Loans: How Will They Affect My Credit Score?

Let’s face it. Many of us have found ourselves in situations where some extra cash could come in handy. Maybe the plumbing in your home has tanked, or you have extra medical expenses. Whatever the reasons, some people might seriously be considering how personal loans might help them financially.

With that consideration also comes the question, “how do personal loans affect credit scores?” It’s actually a good question to ask.

As with most things — there are two sides to the coin. A personal loan has the potential of impacting your credit score positively or negatively. Knowing what the risks are may make it easier for you to make the decision whether to apply for a loan or not.

What exactly is a personal loan?

A personal loan can be used for just about anything and isn’t intended for something specific like buying a car or a home. You can use the money for a home renovation project, foot some of the bill for a wedding, or to pay down some bills — anything for which you need a cash layout. These loans are unsecured which means they don’t require any collateral from you, so be prepared for higher interest rates.

You can secure these loans from banks, credit unions, or online lenders. The terms of the loan will likely coincide with your credit score and other factors such as the loan amount. As long as your credit score is good, you will likely get approved for a personal loan.

How a personal loan might help your credit score

A personal loan can help to improve your credit score as long as it’s used in the right way. Here are some of those:

A reduction in your credit utilization ratio. A personal loan is an installment loan and as such, it won’t factor into your credit utilization ratio which is how much of the credit available to you you’re actually using. Actually, using a personal loan to pay down your credit card debt will likely improve your credit score since credit card debt is considered to be revolving debt which does affect your credit score.

Gives you a better blend of credit types. When you have different types of credit, it bodes well for your credit score. A personal loan is not revolving credit like a credit card is. Adding a personal loan to the mix might boost your credit score.

Helps with your payment history. When you have a personal loan and you make payments for it on time, you’re working toward a positive payment history. That, too, can increase your credit score. Just remember to pay on time each month and pay what you’re supposed to pay.

The downsides of a personal loan

It’s up to you to weigh the pros and cons of a personal loan. Knowing the good and the not-so-good will help you to make the decision about whether or not to sign on the dotted line.

Your debt will increase. Getting a personal loan will, of course, fatten your debt load. If you’re wanting the loan to pay off debts that carry higher interest charges, you might want to do some soul searching and pinpoint why you’re in debt in the first place. Living within your financial means is important.

You’ll get an inquiry on your credit report. All lenders ask to see your credit report when you apply for any type of credit, including a personal loan. This is what is known as a hard inquiry which will likely result in your credit score dropping. Be careful about how much credit you’re applying for since too many hard inquiries will mess up your credit score, for sure.

Added fees. Not only will you be paying interest on a personal loan, but they usually come with some type of fees, including late fees. Make sure you understand what those fees mean before agreeing to a loan.

The bottom line

A personal loan can be great for improving your credit score, consolidating credit card debt, or for seeing to unexpected expenses. No loan comes with some costs and some risks. Just make sure you’re financially able to repay the loan or your credit score will ultimately suffer.

When handled correctly, a personal loan can have a positive impact on the elements used to create your credit score. Taking out a personal loan can actually be pretty financially savvy!