When Does A Personal Loan Help or Hurt Your Credit Scores

A personal loan can be used for just about anything. Personal loans are a great tool to consolidate debt, cover home improvement expenses, and can be a lifesaver during emergencies. But before you apply for one, it’s essential to know what to expect and how to get the best deal. 

Personal loans may have long-term effects on your credit scores, both positive and negative. Before you take out a personal loan, it’s crucial to understand how this type of borrowing can impact your credit.

Positive Effects of a Personal Loan on Your Credit Scores

Taking out a personal loan can positively impact your credit scores in several ways. First, borrowing money and repaying it on time shows lenders that you’re responsible for debt and can be trusted to repay future loans. 

To make timely payments on a personal loan, you’ll need to create a budget and ensure that your expenses are less than your income. While this can be difficult, it’s essential if you want to stay out of debt. Or you can set up automatic payments to never miss an installment.

You should also make sure to pay more than the minimum amount each month so that you can reduce the interest you pay. If you’re having trouble making payments, be sure to contact the lender immediately so that they can work with you to find a solution.

Another positive effect of having a personal loan is that it can add length to your credit history, which is another factor that creditors consider while assessing your creditworthiness. Having a long credit history indicates that you’re capable of handling debt over an extended period, which can be helpful when applying for a mortgage or car loan. 

Long credit history can help boost your credit scores, making it easier to obtain financing when you need it. Finally, a personal loan can help you build up your credit score by increasing your total available credit and helping you maintain a good utilization ratio.

A good utilization ratio is essential in maintaining a high credit score. When you have a high utilization ratio, it means you’re using a large percentage of your available credit, which can be harmful to your credit score, as it suggests that you’re not managing your debt responsibly. 

On the other hand, having a low utilization ratio means you’re using a small percentage of your available credit. It demonstrates to lenders that you’re not over-leveraged and can afford to take on more debt. 

There are many benefits to having a low utilization ratio, including lower interest rates on future loans, higher credit scores, and increased borrowing power.  

Negative Effects of a Personal Loan on Your Credit Scores

Taking out a personal loan can have negative consequences for your credit scores. First and foremost, missing or making late payments on a personal loan can damage your credit significantly. 

A history of missed or late payments can indicate to creditors that you are unreliable and may not be able to repay your debts. Lenders will be taking a risk if they let you borrow money from them. So even if you get approved for a loan, you’ll get a less stellar deal. The conditions for approving bad credit borrowers often include higher interest rates, and a lower credit score can make it more difficult for you to borrow money in the future.

What’s more, lenders often make a hard inquiry when you apply for a personal loan. It happens when a lender checks your credit history to determine if you are eligible for a loan. Too many hard credit inquiries mean you are a riskier borrower and desperate for credit.

Also, this inquiry can ding your credit score by five points or more and stay on your credit report for two years. Consider going through a personal loan pre-approval process to have an idea of whether your loan application will be successful or not. It will provide you with the best answers to get a loan.

This process is considered a soft inquiry and will not affect your credit score. So, you don’t have to worry about a drop in your credit score. 

Bottomline

If you’re thinking about taking out a personal loan, be sure to weigh the pros and cons carefully before making a decision. And remember, it’s always best to consult with a credit counselor or financial advisor if you have any questions or concerns. By knowing the positive and negative effects of a personal loan on your credit scores, you’ll be able to make an informed decision about whether or not this type of loan is right for you.

Adam Hansen