Can a personal loan hurt my credit score?
It depends on the situation
See if a personal loan can harm your credit score.
Every now and then, you might find yourself in a tight corner financially. It happens. At such a time, you might have an immediate need to take care of. What to do?
Personal loans are viable options you can get through banks, credit unions, and even online lenders. Borrowing from these institutions can help you take care of whatever pressing need you currently face. But do personal loans typically have adverse effects on your credit score?
The answer to this question depends on the situation. Let’s consider the various situations involving personal loans to find out the effect on your credit score.
1. Applying for a personal loan
As we mentioned, sometimes needs come up and you might not have the cash to get everything sorted out right away. In such a situation, you can apply for a personal loan. When you apply for a personal loan, the potential lender initiates a hard credit check.
A hard credit check reduces your credit score a bit, so applying for a personal loan will hurt your credit score.
2. Making payments toward a personal loan
Repaying your personal loan is crucial to your credit health. In fact, according to FICO, your payment history makes up 35% of your credit score.
If you consistently repay your personal loan on time, the financial institution will notify the three major credit reporting agencies of such activity. Your credit report and credit score will reflect this positively.
However, if you miss payments by more than 30 days, the credit reporting agencies will also hear about it. Late payments on your credit report hurt your credit score.
3. Pre-qualification with potential lenders
Just as credit card companies assess consumers’ financial standing to pre-qualify them for credit cards, lenders typically do the same.
The assessment involves a soft credit check. Potential lenders run soft credit checks as a form of preliminary inquiry into your credit. Soft checks do not hurt your credit score at all; they’re different from hard credit checks.
4. Debt consolidation
Consolidating debts into a personal loan involves compiling different debts into one payment. This effectively reduces your credit utilization ratio.
Your credit utilization ratio accounts for a significant portion of your credit score. If you use very little of your available credit, it improves your credit score, but if you use a lot, it decreases your credit score. Thankfully, consolidating your debts into a personal loan reduces your credit utilization ratio, thereby increasing your credit score.
5. Credit mix diversification
A healthy credit mix favors your credit score. If, for any reason, you have only one or two kinds of credit, your score is going to take a hit. However, if you have credit cards, mortgage loans, auto loans, and other kinds of credit and you proceed to throw a personal loan into the mix, then all the better for your credit score!
A personal loan can either hurt or help your credit score, depending on the situation and how you handle the loan repayment. Read our post on things that can hurt your credit score for more information and a deeper insight into the financial habits you need to avoid.
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