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Loans

Here's how personal loans can impact your credit

Select breaks down the ways a personal loan can positively and negatively impact your credit score.

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When it comes to paying for some of life's biggest expenses — a home renovation, a big medical bill, an emergency, a wedding or even a funeral — many people find themselves short on the cash needed to cover these costs right away.

A personal loan is a form of credit that can come in handy in these instances. And according to a 2019 Experian study, personal loans are the fastest growing form of debt in the U.S. But when it comes to taking on any form of additional debt, consumers should take time to think about how this new line of credit can affect their financial life, including their credit score.

So does taking on a personal loan impact your credit score positively or negatively? Really, it depends.

Why use a personal loan in the first place

Personal loans generally allow you to borrow money at a much lower interest rate than if you were to put the expenses on a credit card. According to the Federal Reserve, the current average APR for a two-year personal loan is 9.58%. By contrast, the average interest rate on a credit card is 16.30%, but can be as high as 24%. So a personal loan can be a cost-effective way to cover a big expense or consolidate debt.

How a personal loan can help your credit score

Taking on a personal loan can help improve your credit mix. Your credit mix refers to the different types of credit accounts you have, including credit cards, loans, mortgages, etc., and it makes up 10% of your credit score.

While it's not necessary to have one of each type of account, having a variety of accounts can show lenders that you have the ability to manage multiple types of credit. This can help you, as financial institutions are more likely to see you as a more creditworthy borrower when you apply for a new form of credit, like a mortgage or car loan. (Just make sure you're not taking on too much debt.)

Personal loans can also help you establish a track record for making on-time payments. Payment history is the most important factor in calculating your credit score — it makes up 35% of it. Making your monthly payments on time and in full can provide clues to a lender that you are very likely to continue paying back the money you owe, should you apply for another line of credit in the future.

This is especially important when you're just starting to build or improve your credit. In fact, while a low credit score is typically a road block to getting approved for most loans, some lenders actually offer personal loans that are geared toward people with fair or bad credit.

Upstart, for example, accepts applicants with a credit score of 600 or below and even those whose credit history is so insufficient that they don't even have a credit score.

OneMain Financial Personal Loans also offers an option for those with fair or poor credit. Before you apply, just keep in mind that taking on a personal loan with poor credit means that you may pay higher interest rates and some fees.

Upstart Personal Loans

  • Annual Percentage Rate (APR)

    3.09% to 35.99%

  • Loan purpose

    Debt consolidation, credit card refinancing, wedding, moving or medical

  • Loan amounts

    $1,000 to $50,000

  • Terms

    36 and 60 months

  • Credit needed

    FICO or Vantage score of 600 (but will accept applicants whose credit history is so insufficient they don't have a credit score)

  • Origination fee

    0% to 8% of the target amount

  • Early payoff penalty

    None

  • Late fee

    The greater of 5% of monthly past due amount or $15

Terms apply.

OneMain Financial Personal Loans

  • Annual Percentage Rate (APR)

    18.00% to 35.99%

  • Loan purpose

    Debt consolidation, major expenses, emergency costs

  • Loan amounts

    $1,500 to $20,000

  • Terms

    24, 36, 48, 60 Months

  • Credit needed

    Poor/Fair

  • Origination fee

    Flat fee starting at $25 to $onem00 or percentage ranging from 1% to 10% (depends on your state)

  • Early payoff penalty

    None

  • Late fee

    Up to $30 per late payment or up to 15% (depends on your state)

Terms apply.

How a personal loan can hurt your credit score

Of course as with any form of credit, irresponsible use of a personal loan can have a negative impact on your credit score. And 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 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.

As a result, you may want to be strategic 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.

Many lenders offer an online tool you can use to figure out what interest rate you'd likely qualify for based on your information. Getting an estimate won't hurt your score and you can be sure you're getting the best interest rate before you submit your application.

Select also has a widget you can use to compare personal loan offers without impacting your credit score. This comparison tool provided by Even Financial will help you find a personal loan that's right for you. You'll be asked 16 questions, including your annual income, date of birth and Social Security number in order for Even Financial to determine your top offers. The service is free, secure and does not affect your credit score.

This tool is provided and powered by Even Financial, a search and comparison engine that matches you with third-party lenders. Any information you provide is given directly to Even Financial and it may use this information in accordance with its own privacy policies and terms of service. By submitting your information, you agree to receive emails from Even. Select does not control and is not responsible for third party policies or practices, nor does Select have access to any data you provide. Select may receive an affiliate commission from partner offers in the Even Financial tool. The commission does not influence the selection in order of offers.

Another thing to keep in mind is that personal loans can be really useful tools for debt consolidation and paying off debt. However, the habits that got you into debt in the first place can cause a personal loan to feel more like an extra financial burden.

For example, if you take on a personal loan to pay off a maxed out credit card but then go ahead and max out the credit card again immediately after, you'll be stuck with more credit card debt and a personal loan to pay off.

This debt cycle can also negatively impact your credit score if the burden of extra payments is so high that you begin missing monthly payments or don't make payments in full and hurt your credit utilization ratio.

Always make sure you have a plan to pay off any additional debt you take on before you even submit your application. And getting to the root of any not-so-healthy financial habits can ensure that you actually solve the problem instead of just managing a symptom of the problem.

Bottom line

A personal loan can be an affordable way to fund a large expense, cover an emergency or even consolidate debt. But much like with any other form of credit, its impact on your credit score can depend on how it's used.

A slight dip in your score after applying is generally to be expected since a lender will run a hard inquiry on your credit. But using a personal loan to diversify your credit mix and making on time payments toward your balance can have a positive impact on your score.

Just be cognizant of any unhealthy financial habits that could easily turn a personal loan from a resource to a burden.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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