Personal loans can be a helpful tool for many financial needs, but they also come with certain impacts on your credit score. Whether you’re looking to consolidate debt, cover emergency expenses, or finance a big project, it’s essential to understand how personal loans affect your credit.
In this post, we’ll break down how personal loans can help or hurt your credit score, when to consider one, and some alternatives that could suit your needs better.
How Do Personal Loans Affect Your Credit?
Applying for a Personal Loan
When you apply for a personal loan, the lender will likely perform a hard credit inquiry. This is a formal check of your credit report, and it can cause a small, temporary dip in your score. But don’t panic! This is a normal part of the process, and the impact is usually minimal. Your score typically bounces back in a few months.
After Getting a Personal Loan
Once you receive the loan, your credit score might dip slightly again. This happens because the new loan reduces the average age of your accounts, which is a factor in credit scoring. But that’s just the start—how you manage the loan from here is what really counts.
How Personal Loans Can Help Your Credit
Lower Credit Utilization Rate
If you use a personal loan to pay off credit card debt, this could reduce your credit utilization ratio—the percentage of your available credit that you’re using. Credit utilization makes up about 30% of your credit score, so lowering it can have a big positive impact on your score.
Improve Payment History
Payment history is the most significant factor in your credit score, making up 35% of your total score. By consistently making on-time payments on your personal loan, you add positive entries to your credit history, which boosts your score over time.
Increase Your Credit Mix
Lenders prefer to see a variety of accounts in your credit history, such as credit cards, mortgages, and personal loans. Adding a personal loan to your credit mix could increase your score by demonstrating that you can manage different types of credit responsibly.
How Personal Loans Can Hurt Your Credit
Missed Payments
While making payments on time can boost your score, missing a payment can do the opposite. If you miss a payment by 30 days or more, it will show up on your credit report and may lower your score significantly.
Increasing Overall Debt
Taking on new debt increases your overall debt load, which can negatively impact your credit score. If you’re not using the loan to consolidate existing debt, adding another bill to your monthly budget could be tricky, especially if it leads to financial strain and late payments.
What Credit Score Do You Need for a Personal Loan?
Your credit score plays a significant role in determining the interest rate and terms of a personal loan. Generally, a higher score will get you better terms. Here’s a quick breakdown:
- Excellent (740+): You’ll likely get the best rates and terms.
- Good (670-739): You can still find good rates, but they may be a bit higher.
- Fair (580-669): You might still qualify, but expect higher interest rates.
- Poor (below 580): It’s possible to get a loan, but the terms will likely include very high interest rates and fees.
When to Consider a Personal Loan
A personal loan might make sense if you’re in one of the following situations:
Managing High-Interest Debt
Using a personal loan to consolidate high-interest credit card debt can save you money on interest and help you pay off debt faster.
Covering Emergency Costs
If you have an unexpected medical bill or emergency home repair, a personal loan can help you cover those costs when your savings won’t cut it.
Financing Home Improvements
A personal loan can be a good option for home improvements, especially if you don’t want to tap into your home equity.
Alternatives to Personal Loans
If you’re unsure whether a personal loan is the right choice for you, here are a few alternatives to consider:
Credit-Builder Loans
These are specifically designed to help people build credit. The lender deposits a small loan into a savings account, and you make payments until the loan is paid off. Your payment history is reported to credit bureaus, helping you improve your credit.
Secured Credit Cards
A secured credit card requires a deposit that serves as your credit limit. It’s a great way to build or rebuild credit, as long as you make on-time payments.
FAQs about Personal Loans
Do personal loans always hurt your credit?
No, personal loans don’t always hurt your credit. If you manage the loan responsibly—by making on-time payments and keeping your debt levels low—it can actually help improve your credit score over time.
How much does a hard inquiry affect my credit score?
A hard inquiry typically lowers your score by a few points, but the effect is temporary. Your score usually recovers within a few months, as long as there are no other negative changes to your credit.
Can I use a personal loan to pay off credit card debt?
Yes! In fact, many people use personal loans for debt consolidation. This can lower your credit card balances, reduce your credit utilization ratio, and potentially improve your credit score.
Are there better options than personal loans for building credit?
If you’re focused solely on building credit, a credit-builder loan or secured credit card might be a better option. These alternatives typically come with lower interest rates and fees compared to personal loans.
FAQs about FUNDSamentally
What is FUNDSamentally?
FUNDSamentally is a personal finance platform that provides tools and resources to help individuals make informed decisions about loans, credit, and personal finance. Our goal is to help you find the best financial products for your needs.
How can FUNDSamentally help me with personal loans?
At FUNDSamentally, we help you compare personal loan options based on your credit score, loan amount, and repayment terms. Our platform makes it easy to find a loan that fits your needs without affecting your credit score.
Does FUNDSamentally offer financial advice?
We don’t provide personalized financial advice, but we do offer informational resources to help you make educated decisions about loans, credit, and financial management.
Whether you’re looking to build credit or just cover an unexpected expense, personal loans can be a useful tool—if used responsibly. Always weigh the pros and cons before borrowing, and explore alternatives if necessary. If you have any questions, FUNDSamentally is here to help!
