Personal loans can have a significant impact on your credit. Depending on how a loan is handled, the impact can be either harmful or beneficial.
There are many factors that can affect your credit when applying for, opening, repaying, or closing a personal loan. Not all of the factors are equal, but they can all have an effect on an individual’s overall credit score.
So, how does your personal loan impact your credit at each stage of the process?
Applying for a Loan
Once you’ve applied for a personal loan, you will likely have to undergo a hard credit check. An in-depth evaluation of your credit history can knock up to five points from your FICO score. It’s important to consider that, in total, approximately ten percent of your credit score is dependent on new credit applications.
A hard credit check can remain on your credit report for around two years. In most cases, it will only have an impact on your score within the first year. Another important note is that, in certain scenarios like shopping around for a mortgage loan, you’ll be given a grace period. During this period, you’ll be able to submit several loan inquiries without multiple credit hits. Instead, these inquiries will be handled like a single application, reducing the damage done to your credit score.
Opening a Loan
Depending on the balance of your new loan, your credit utilization rate (the amount of available credit you’ve used) will vary. Credit utilization contributes up to 30% of your credit score. As a result, your loan balance can impact your credit score to varying degrees. When you take out a loan with a high balance, there will be a larger initial hit on your score, while a lower balance loan will have less impact.
Despite the initial impacts on your credit score, FICO bases a large portion of your score on how you handle the repayment process. Timely payments are seen as proof to creditors that you’ll be a reliable investment. If you make your loan payments on time, you’ll soon begin to replenish your credit score in the short term. In the long term, a pattern of timely loan payments can help you to build excellent credit.
Conversely, loan payments over thirty days late can do significant damage to your credit score. Worse, delinquent payments stay on your credit report for seven years from the date of the missed payment.
Completing Your Loan
Successful repayment of a loan can have a noticeably positive effect on your score. However, you may see an initial credit hit if the loan is your only installment-type account, as credit bureaus prefer a mix of installment type and revolving type accounts.
Defaulting on a loan is detrimental to your credit score. Defaults stay on your credit report for as many as seven to ten years after the account is resolved.
Through every stage of the loan process, personal loans have the potential to impact your credit score. If you can prove to lenders that you’re a reliable investment you’ll see a net positive effect.