How personal loans affect credit scores

Whether you want to make a big purchase, consolidate high-interest debt or need cash quickly, you might be considering a personal loan. If you are considering a personal loan, it’s worth keeping in mind that it could have long-term effects on your credit scores—depending on how you manage the loan.

But how exactly it could affect your credit scores is hard to predict. That’s because there are many different credit scoring models from companies like FICO® and VantageScore®. And it also depends on your own unique financial situation. But generally, a personal loan could either help or hurt your credit scores. Read on to find out how.

A loan application could result in a hard inquiry. This occurs when a bank or other lender looks at your credit report as part of a review of your application. A hard inquiry can have a negative effect on your credit scores and stay on your credit report for up to two years. But how much your scores are affected can depend on your specific financial situation.

Having too many inquiries on your credit report—especially within a short period of time—may also have an impact, the Consumer Financial Protection Bureau (CFPB) says. And if your credit report shows multiple credit applications within a short period of time, it might appear to lenders that your finances have changed negatively.

You might avoid any unnecessary credit inquiries by checking your credit reports and scores before you apply. As the CFPB points out, checking your credit reports and scores could give you a better idea of whether you’ll be approved. Generally, the better your credit scores, the more likely you are to be approved. 

You could also consider going through a pre-approval process. Seeing whether you’re pre-approved before you apply doesn’t guarantee that your loan application will be successful. But it could give you a hint. And it counts as a soft inquiry, which has no impact on your credit scores, according to the CFPB. 

Personal loans could be reported to the credit reporting agencies. If yours is, it could be considered when your credit scores are calculated. That means that a personal loan could hurt or help your credit scores. 

The amount and age of a loan can affect your credit scores. But it’s not only the loan itself that affects your credit scores. How you actually manage the loan also affects your credit scores. 

It’s important to make payments on time and avoid late payments or missing payments altogether. As the CFPB points out, your payment history plays a part in your credit scores. And the better your payment history, the better your credit scores might be. But if you’re late or miss payments, that could hurt your credit scores.

If your personal loan is reported to the credit reporting agencies, the loan could help your credit scores. But remember, it’s not only the loan itself but how you handle the loan that can make the difference. 

Here are a few ways a personal loan might have a positive impact on your credit scores. Keep in mind, though, that there are many other factors that affect your credit scores. And you’ll need to keep an eye on them all if you want to get and keep good credit scores.

If you make on-time payments

Making on-time payments every month could help you build a positive payment history. And according to the CFPB, a good payment history could help you improve your credit scores or maintain good credit scores. 

If you need help keeping up with bill payments, you could set up a budget, automatic payments or reminder alerts.

If it diversifies your credit mix

A personal loan is a type of credit known as an installment loan. With a personal loan, you borrow money and pay it back in equal installments over a fixed period of time. 

But a credit card account is an example of revolving credit, meaning it can be used and paid down repeatedly. So if your only source of credit has been from credit cards, the addition of a personal loan would diversify your credit mix. And a diverse credit mix could improve your credit scores.

Taking out a loan still means taking on more debt, though. And a good credit mix likely won’t help your credit scores if you can’t keep up with your payments.

If it helps you lower your credit utilization ratio

Your credit utilization ratio is a measure of how much of your available credit you’re using. For a good credit score, the CFPB recommends you keep your credit utilization below 30% of your available credit. But credit utilization only applies to revolving credit accounts like credit cards, personal lines of credit and home equity lines of credit.

A personal loan doesn’t factor into your credit utilization because it’s a form of installment credit—not revolving credit. But using a personal loan to pay off revolving-credit debt could lower your credit utilization. And according to the CFPB, keeping your credit utilization low could help you improve your credit scores or keep good credit scores.

Keep in mind that lowering your credit utilization won’t help your credit scores if you aren’t responsibly managing the other factors that affect your scores.

To find out what impact your personal loan is having on your credit scores, you can check your credit report regularly. You can get free credit reports from each of the three major credit bureaus. Visit AnnualCreditReport.com to learn how.

And with CreditWise from Capital One, you can access your free TransUnion® credit report and weekly VantageScore 3.0 credit score anytime, without hurting your scores. CreditWise is free and available to everyone—not just Capital One customers.