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How Do Personal Loans Impact Your Credit Score?

A personal loan can affect your credit score in several ways – good and bad. Taking out a personal loan isn’t necessarily bad for your credit score. However, it may affect your overall credit score in the short term and make it more difficult to obtain additional credit before the new loan is paid back.

What is a Personal Loan?

Loans for car purchases and home mortgages are for specific purchases and are not considered personal loans. Personal loans are consumer loans that can be used for almost anything you want.

You may need a loan to start a new business, pay medical bills, or for an emergency home repair. You may also apply for a personal loan to consolidate credit card debt as personal loans have a lower interest rate than most credit card debt.

Do You Need a Personal Loan?

Maybe you have been surprised by unforeseen medical expenses, an emergency home repair, or a car repair and you just don’t have the cash immediately available to pay for it, or your credit card balance has gotten significantly out of hand.

In the examples above, you need to take on more debt in the form of a personal loan for a short period of time. A personal loan can allow you to pay for major expenses when you don’t have the cash on hand. However, a personal loan can affect your credit score either positively or negatively.

The Negative Impacts on Your Credit Score

A couple of factors of how a personal loan can impact your credit score negatively:

  • Credit inquiries reduce your credit rating: The credit check that the lender does will harm your credit score.
  • Increasing debt reduces your credit rating: Taking on more debt with a personal loan will impact your credit score negatively.

The good news is that these negative effects are often short-lived, meaning they won’t have any long-term effects on your credit score.

The Positive Impacts on Your Credit Score

Depending on how you utilize a personal loan, it can help to improve your credit score.

  • Contributes to a better credit mix: Having a variety of different types of credit can help boost your credit score. Compared to simply having credit cards, a personal loan where you are fulfilling your regular payment commitments will have a positive impact on your credit score.
  • Helps build a payment history: Making personal loan payments on time establishes a positive payment history, which can increase your credit score.
  • Reduces your credit utilization ratio: A personal loan is an installment loan and is not a factor in your credit utilization ratio, which measures how much of your available revolving credit you’re using. Using a personal loan to pay off revolving credit such as credit card debt helps to improve your credit score.

Your overall credit history has more impact on your credit score than a single loan. If you have a long history of managing debt and making timely payments, the impact on your credit score of taking out a new loan is likely to be lessened. The easiest way to keep a personal loan from lowering your credit score is to make sure you make your payments on time.

This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.

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