Every now and then, you need a little help with your finances. A personal loan is one way to smooth your finances or get extra cash for a purchase. An unsecured personal loan can allow you to accomplish some of your goals without the need for collateral, or to share a specific purpose with the lender.
But whenever you get any loan, it’s important to consider the impact on your finances and on your credit.
Before you apply for a personal loan, consider the credit score factors that are likely to be a part of the equation. Any debt impacts your credit — and that means a personal loan can affect your situation as well.
But that doesn’t mean the effects of a personal loan will be all negative. In fact, when used properly, a personal loan can have a net positive impact on your credit, and that means it can also have an effect on your life and finances beyond just your credit rating.
What happens to your credit when you apply for a personal loan?
According to FICO, the company that provides the most popular formulas for calculating credit scores, there are five main credit score factors that each carry a specified weight:
- Payment history: 35%
- Amounts owed: 30%
- Length of credit history: 15%
- New credit: 10%
- Credit mix: 10%
With a personal loan, the main things that affect your credit score fall under the categories “length of credit history” and “new credit.” When you apply for a personal loan, that represents an inquiry that will show up on your credit report and impact your credit score.
It doesn’t mean it will be a huge impact, though. FICO’s website says that for most people, a credit inquiry, like one for a personal loan, will likely only drop a credit score by about five points.
Things change if you are making a lot of credit inquiries in a short period of time, however. The more loans you apply for in a short timeframe, the bigger the impact on your credit history.
Your new credit will also have an impact on your credit history. Part of the calculation of credit history is the average age of your accounts. A new credit account, like your personal loan, brings down the average age of your accounts.
However, the impact shouldn’t be too huge, as long as you don’t have a lot of newer credit dragging on your score.
Once you get your personal loan, it’s important to pay attention to how you manage it, since that’s what will matter most to your credit score going forward.
Don’t let a personal loan bring down your credit score
Simply getting a personal loan isn’t likely to have a long-term negative impact on your credit. You might be surprised to discover that a personal loan can actually help your credit score in the long run.
Of the credit score factors, the most important item is your payment history. FICO counts it at 35% of your score, and most other credit scoring models heavily weight your payment history.
As long as you make your loan payments on time and in full, your score will be impacted positively. The more on-time payments you have, the better your credit score.
With a personal loan, factors that affect credit score most are the payments you make and the mix that your loan adds to your credit profile.
Adding a personal loan to your credit mix can actually give your score a little boost. While credit mix is only 10% of your score, it can still provide a little help. Showing that you can handle an installment loan as well as a revolving credit loan (such as a credit card) can add to your score.
The opposite is true, too. If you miss payments on your personal loan, you will be penalized. When you get any type of credit, it’s vital that you make regular payments in order to prevent damage to your credit score.
A personal loan is most dangerous to your credit when you don’t make payments.
Only borrow what you need
Any time you borrow money, it’s important to limit your loan to what you need to accomplish your goals.
A personal loan can be a way to consolidate your debt to make it easier to pay off, or to help you smooth your cash flow while you restructure your finances. No matter what you use your personal loan for, don’t borrow more than you can handle and avoid paying late.
Your installment loan won’t have the same impact in the credit utilization measure of your credit score, but it can still impact decisions about your finances in the future.
Lenders and others look at your credit file for red flags. If you have a large personal loan, it can affect your ability to get other credit and financial products, even if you have a good credit score. Lenders and others assess risk, and a large personal loan can make you a bigger financial risk.
Personal loans can help your finances, and even provide a boost to your credit, but you need to be careful about how you apply for and use them.
Interested in a personal loan?Here are the top personal loan lenders of 2018!
|Lender||Rates (APR)||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|7.73% - 29.99%||$1,000 - $50,000|
|5.37% - 14.24%1||$5,000 - $100,000|
|8.00% - 25.00%||$5,000 - $35,000|
|4.99% - 16.24%2||$5,000 - $50,000||Visit Citizens|
|5.99% - 35.89%||$1,000 - $40,000||Visit LendingClub|
|5.25% - 14.24%||$2,000 - $50,000||Visit Earnest|