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Are Personal Loans Bad for Your Credit Score?

Obtaining a personal loan is often a necessary part of life. For example, you may need a loan to help with unexpected expenses or large purchases such as a house or an automobile. But are personal loans bad for your credit score? 

Short Answer: A long credit history with on-time payments is the best way to improve your credit score. Although inquiries for loans and credit may lower your score, a personal loan can add to your credit diversity and improve your score. Conversely, failure to make on-time payments or having too much credit on your income will negatively affect your score. 

Below, we will look at your credit score and how personal loans can negatively or positively affect your score. 

  • 35% Payment history
  • 30% Outstanding debt
  • 15% Credit history
  • 10% New credit
  • 10% Credit mix

There are three major credit reporting agencies in the United States. They are TransUnion, Equifax, and Experian. They all have slight differences, but all produce the same score based on these five factors. 

Do Personal Loan Applications Affect Your Credit Score?

Obtaining a new loan or attempting to obtain a loan could affect your credit rating. This is because credit reporting agencies check on any new debt you attempt to acquire. The increased debt-to-income ratio can also have an impact on your credit score. This can cause the rejection of future loan applications if you do not have sufficient income to cover your debts. 

Pre-qualifying for a loan with a general inquiry of your credit score will not negatively affect your score. It will allow you to compare lenders and loan terms to achieve the best rate and loan terms for the amount you are attempting to secure. However, applying for the loan will require a different credit check and can decrease your credit score by up to 5 points.  

Your credit history will have the most significant impact on your overall credit score. The longer your credit history is, plus making your payments on time, will have the most significant positive impact. If your debt-to-income ratio isn't too high, a new line of credit or credit inquiries won't have a big effect on your credit score.

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Can Personal Loans Boost Your Credit Score?

Having a loan payment history is necessary to show you can handle debt and can repay a loan. Consistent, on-time long-term loan payments are the best way to boost your credit score. If you continue making on-time payments and repaying your loans according to the terms, it will positively impact your credit score. 

A personal loan for debt consolidation can also help strengthen your credit score. It will improve your credit-to-income ratio and help you pay off your debt faster. Personal loans also have much lower interest rates than credit cards and other debts you may have. If you take out a personal loan instead of paying off your credit cards one by one, you could save a lot of money in the long run.

The higher your credit score and the lower your debt-to-income ratio is, the better the chance you will have when attempting to secure a loan. This is because most people have positive credit ratings in the good or excellent tiers. For example, the average credit score in 2020 was 710. Combined with a debt-to-income ratio under 30%, these factors will give you the best possible credit score. 

What Lowers Your Credit Score? 

Missing a due date on your loans by just a few days will not affect your score. However, being over 30 days late or missing payments completely will have the most significant negative impact on your credit score. This is because all payments more than 30 days late will be reported to the credit agencies and can drop your score significantly. 

Individuals who do not have a loan history or avoid taking loans also have low credit scores. A lack of credit history can negatively affect getting a personal loan when you are attempting to make a major purchase.  

What Credit Rating Do You Need for a Personal Loan? 

The higher your credit score, the more likely you will be approved for a personal loan. Credit scores above 670 show you can take on debt and can repay that debt. Credit scores fall into five categories, as shown below:

  • Poor: below 580
  • Fair: 580 to 669
  • Good: 670 to 739
  • Very Good: 740-799
  • Exceptional: 800 and over

Your credit score isn't the only factor lenders consider when determining if you qualify for a personal loan. Your amount of income, employment history, and current bank balance can all play a factor when you apply for a personal loan.

Conclusion

While the necessary inquiries into your credit history can negatively affect your credit score, personal loans will positively impact your overall credit score. This is because they will give your credit rating diversity, and when paid according to the agreement with the loan specifications, they are the best to boost your score. Your credit score will also increase if you have a long and varied credit history.

Missing payments and a lack of credit history will have the most significant negative impact on your credit score. All payments that are late for more than 30 days are reported to credit agencies. This can hurt your chances of getting credit and personal loans in the future. 

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