There are a few ways that applying for and taking out a personal loan can affect your credit.
Much like with any other loan, mortgage or credit card application, applying for a personal loan can cause a slight dip in your credit score. This is because lenders will have to run a hard inquiry on your credit, and every time a hard inquiry is pulled, it shows up on your credit report and your score drops a bit. Keep in mind, though, that this dip is only temporary and continuing with good credit habits can increase your score again over time.
This being said, though, it’s worth it to be as strategic as possible about when you decide to apply for a personal loan. Applying for a personal loan soon after applying for a new credit card could cause an even bigger drop in your credit score since a hard inquiry would be run for both applications.
On the plus side, taking out a personal loan can in fact help your credit score as you establish a track record for making on-time payments. This is especially true if you’ve been approved by a lender that accepts applicants with an insufficient credit file. Payment history is the most important factor in calculating your credit score, making up 35% of it. Completing your monthly payments on time and in full can provide clues to a lender that you are very likely to pay back any money you borrow in the future. As a result of making consistent on-time payments, your credit score is likely to increase.
A personal loan can also help improve your credit mix. Your credit mix refers to the different types of credit accounts you have, including credit cards, student loans, mortgages, etc., and it makes up 10% of your credit score.
That’s not to say that you should go out of your way to take on different kinds of debt, but having a variety of accounts can show lenders that you have the ability to manage multiple types of credit. This can make you seem more like a creditworthy borrower (just make sure you’re not taking on too much debt).
Personal loans — and the idea of taking on more debt — can seem daunting, especially if you already have a low credit score or no credit history at all. But when used responsibly, they can help you cover a large, necessary expense and better your credit score as you make on-time payments. If you’re applying for a personal loan with poor credit, you’ll just need to keep the above things in mind so you don’t feel blindsided during the process.