Do personal loans affect your credit?
Personal loans have the potential to improve your credit score, but may cause an initial dip.
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Jessica Walrack is a freelance finance writer and journalist with over a decade of experience. During that time, she’s written hundreds of articles about loans, insurance, banking, mortgages, credit cards, budgeting, and taxes for well-known publications including CBS News MoneyWatch, USA Today, US News and World, Investopedia, and The Balance Money.
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Jared Hughes is a personal loan editor for Credible and Fox Money, and has been producing digital content for more than six years.
Updated May 16, 2024, 5:42 PM EDT
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In many cases, your credit score will drop by a few points when you take out an installment loan like a personal loan. The application process can cause a decrease, as can adding a new account with an outstanding balance to your report. But as you make consistent, on-time payments and show you can manage the debt, the loan should help your score grow.
According to an Experian survey from the third quarter of 2023, nearly half of respondents reported planning to use a personal loan in 2024. Here's what exactly that decision could mean for your credit, along with tips on how to responsibly manage your loan.
What is a personal loan?
Personal loans are a type of installment loan that typically allow you to borrow a lump sum at a fixed annual percentage rate (APR) and repay the funds in equal monthly payments over a set term, usually two to seven years, with interest. You can use the funds for nearly any purpose, though there are some restrictions - typically against paying for college tuition or making a down payment on a house.
APRs on personal loans typically range from around 7% to 36%. The rate and amount you qualify for (or whether you qualify) depends on the lender you choose and your credit score and income, among other factors. The average APR on a two-year personal loan was 12.49% as of February 2024, according to the Federal Reserve.
Keep in mind
If you have poor credit (defined by FICO as a score under 580), you may have a harder time getting approved for a personal loan than someone with good credit. If you do qualify, know that you’ll likely face higher-than-average rates.
Prequalifying for a personal loan
Many lenders or loan marketplaces allow you to input some personal information, such as your name, date of birth, and Social Security number, in order to view possible rates, terms, and amounts you could qualify for.
Prequalification is not an offer of credit (your final rate could be higher, and there's no guarantee you'll be approved even if you prequalify), but it's a valuable tool for comparing potential loans and lenders, as it only requires a soft credit inquiry that doesn't hurt your score. Proceeding to apply for a loan is what requires a hard inquiry that can bring down your score.
How personal loans can help your credit score
On-time payments
What to know: Consistent and timely payments will help maintain and boost your score
As you make each monthly payment, you'll be demonstrating responsible management of your loan, which can steadily build your score. If your score has been damaged, it's still possible to improve your score by catching up on payments. If you're having a problem making payments, consider contacting your lender to see if they can help, or meet with a credit counselor who can assist with budgeting.
Potential credit utilization decrease
What to know: Paying down revolving accounts with a personal loan could be beneficial
Credit utilization is part of the second-most important category in the FICO credit scoring model, amounts owed. It helps account for 30% of your score, and measures the amount of credit you're using on revolving accounts like credit cards and lines of credit. If you use a personal loan to pay down a revolving credit line, it can give your score a boost by decreasing that ratio.
Tip
Personal loans won’t cause your credit utilization to increase because, as installment loans, they’re categorized differently than revolving credit lines.
May contribute to credit mix
What to know: Lenders like to see that you can manage multiple types of credit
Your credit mix helps lenders judge if you can successfully manage both revolving and installment accounts, and makes up 10% of your FICO score. If you don't have any installment accounts yet, a personal loan may help diversify your credit mix and improve your score.
Compare personal loan rates
Personal loan factors that may hurt your credit score
Missed or late payments
What to know: Payment history makes up the largest part of your FICO score (35%)
Lenders check your credit primarily to gauge whether they think you'll repay your debt. A history of missed or late payments on your report is a red flag that can make it hard to get approved, and the marks could affect your score for up to seven years. It's essential to ensure you can comfortably afford and keep up with the payments before taking out any form of credit.
A new loan on your report
What to know: A new balance can make lenders see you as a higher-risk borrower
The total amount of debt you owe on all of your accounts, including installment loans, contributes to 30% of your FICO score. With a new loan, you haven't yet had a chance to demonstrate you can manage the new payment, increasing your perceived risk to lenders. Paying down the balance with consistent, timely payments can help mitigate this impact.
A lower average account age
What to know: How long your accounts have been open determines 15% of your score
More specifically, FICO considers the average age of your credit accounts and the age of your oldest and newest accounts. Time is your friend when it comes to this category, so a new loan that brings down the age of your newest account, as well as their average age, can ding your score.
Applying for a loan
What to know: Each hard inquiry on your account has the potential to lower your score
When you apply for new credit, the lender will typically perform a hard inquiry to check your credit, which can lower your score by a few points. New credit inquiries on your report make up 10% of your FICO score. While hard inquiries stay on your report for two years, they only impact your score for one.
How debt consolidation affects credit
A common use for personal loans is to consolidate debt - especially high-interest debt with variable rates, like credit cards. While debt consolidation loans can have the same initial negative effects on your score as other personal loans, they can also allow you to pay off revolving balances. This could mean a rapid decrease in your credit utilization and a significant jump in your score.
Important
Keeping revolving accounts open — and balances low — can help maintain a score increase from consolidation. But if you’re struggling to manage your cards, closing them to avoid racking up more debt may be worth the hit to your average account age.
Tips for managing a personal loan responsibly
Responsible management of a personal loan starts before you even apply.
- Consider your loan amount carefully: Review your income and expenses to identify a loan amount and monthly payment that will comfortably fit into your budget and that you'll be able to afford for your desired term. Once you have a limit in mind, stick with it.
- Make payments consistently: Plan ahead to ensure you'll make each payment on time or early. It can help to set up automatic payments from your bank account so you don't have to manually make the payments, but be sure to pay attention to your accounts and make sure the payments go through.
- Communicate with your lender: If you end up unable to make a payment, contact the lender as soon as possible to discuss your options. It may allow you to defer a payment to the end of the term, for example, which can help you avoid a default and credit score damage.
- Keep up with your credit: Check your credit report periodically to ensure everything is up-to-date and accurate. You can visit AnnualCreditReport.com for free credit reports. Dispute any inaccurate information to the appropriate bureau.
Personal loans and credit FAQ
How can a personal loan help my credit?
If you take out a personal loan and pay it off as agreed, your payment history will show that you've managed an installment loan responsibly, which helps your score. FICO scores also reward borrowers who have a mix of revolving and installment credit accounts. If you don't have an existing installment loan, a personal loan could help diversify your credit mix. And if you use one to pay off revolving debt, you could decrease your credit utilization and boost your score.
How does a personal loan affect my credit score?
The FICO credit scoring model considers your payment history, amounts owed, credit mix, credit history length, and how frequently you request new credit - all of which are impacted by a new personal loan. You may see an initial score dip after taking out a personal loan, but your score and overall credit profile can improve over time if you make your payments consistently and on time.
What are no-credit-check personal loans?
No-credit-check personal loans often refer to small, short-term loans like payday loans that don't require a hard credit inquiry, but be wary. Payday lenders may approve borrowers after processing only a soft credit check or verifying an income source, but come with fees that can result in significantly higher APRs than traditional personal loans, up to 400% or more, in some cases.
APRs from reputable lenders usually top out at 36%. Payday loans can also sometimes renew or roll over for a fee, which can trap you in a cycle of debt, and eventually hurt your score if you default and your account is sent to collections.