Does Applying for a Personal Loan Hurt My Credit Score: Need a financial boost but worried a personal loan will wreck your credit score? You’re not alone! Many people considering personal loans wonder if the application process itself will damage their creditworthiness. The answer is both yes and no, but the good news is you have control over the long-term impact. Let’s understand the implications of personal loans on your credit health.
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Shopping for Rates
Many lenders offer pre-qualification with a soft credit check. This quick peek at your creditworthiness doesn’t affect your score and allows you to compare rates without penalty. Look for lenders with soft inquiry pre-qualification to shop around freely. It allows lenders to gauge your eligibility for a loan without diving deep into your credit history.
Diversity is key, even in your credit portfolio. Having a mix of credit products, like installment loans (personal loans) and revolving credit (credit cards), boosts your score. Since credit mix makes up 10% of your FICO score, including a personal loan can be a plus, as long as you manage repayments responsibly.
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Applying for a Loan
The formal application process triggers a hard credit check. It is a more thorough examination of your credit report requested by lenders when you formally apply for a loan. This check also gives lenders a chance to present various personal loan features that suit your financial profile. It usually knocks a few points (up to five) off your score, but responsible lenders require your consent before initiating one.
While it stays on your report for two years, it only affects your score for the first year. However, avoid applying for multiple loans in a short period, as this can lead to a more significant drop in your score.
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Getting the Loan
Adding a new loan can affect your score in two ways. First, new credit accounts make up 10% of your FICO score. If you have recently opened several accounts, a personal loan might cause a slight dip.
Secondly, a new loan can lower the average age of your overall credit history, which is another factor impacting your score (15% of FICO). It is because a new account “pulls down” the average. However, the positive impact of on-time repayments can outweigh this in the long run.
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Repaying Your Loan
On-time payments are the single most significant factor affecting your credit score (35% for FICO). Every timely payment you make on your loan contributes positively to your payment history and strengthens your credit score.
Personal loans themselves don’t directly affect your credit utilization ratio. However, if you use a personal loan to pay off credit card debt, it can significantly lower your overall credit utilization. A lower credit utilization ratio implies a higher credit score.
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Missing a Loan Repayment
Missing a due date can have severe consequences. Payments delinquent by more than 30 days get reported to credit bureaus. It may lower your score by 90-110 points and stay on your credit report for up to seven years. The severity of the damage depends on the number of missed payments and how long they’re delinquent.
Make a budget that includes your loan payment. Setting up automated payments ensures you never miss a due date.
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Debt Consolidation
Replacing high-interest credit card debt with a lower-interest personal loan simplifies your finances in several ways. It can reduce your monthly payments, making it easier to handle your debt and avoid missed payments. A lower credit utilization ratio due to the consolidation can further improve your credit score.
Here are some things to keep in mind:
- Don’t use the freed-up credit card limit to rack up more debt.
- Carefully compare offers based on various personal loan features like discounts on interest rates, loan tenure, any associated fees, monthly payments, etc.
- Consider the total repayment cost.
- Ensure the savings outweigh the costs compared to your existing credit card debt.
Conclusion
While personal loans can cause a temporary dip in your score due to inquiries, the power lies in your hands. Make informed decisions by shopping around with soft credit checks, spacing out loan applications, and prioritizing on-time payments. With responsible debt management, you can watch your credit score climb alongside your financial well-being.