What Does Taking Out a Personal Loan Do to Your Credit Score?

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A personal loan is reported to the credit reporting agencies. Take a look at what this could mean for your credit score. 

A personal loan is one of several borrowing options available to you. You might want to take out a personal loan instead of using a credit card if you’re financing a larger purchase, want a lower interest rate, or would prefer a set payoff schedule.

If you do take out a personal loan, though, you may be wondering how that debt will impact your credit score. Here’s what you need to know.

You’ll get an inquiry on your credit report

If you apply for a personal loan, lenders will check your credit. When this happens, an inquiry is listed on your credit report. An inquiry simply shows future lenders and the credit reporting agencies that you made a request for new debt. But too many of those requests can adversely affect your credit — borrowing a lot of money over a short time period could make it seem as if you’re spending irresponsibly and may run into trouble paying the bills.

Typically, inquiries take about five points off your credit score. However, people with a short credit history or who get a lot of inquiries may see their score drop more. So you need to take this factor into account when understanding how applying for a personal loan will impact you.

The inquiry will stay on your credit report for around two years. During that time, future lenders may also ask you about the inquiry and whether it resulted in you actually borrowing.

You’ll shorten your average age of credit

The age of your credit history typically accounts for about 15% of your credit score in most scoring formulas, including FICO(your FICO® Score is the one most commonly used by lenders). When you take out a personal loan, you have a new account on your record. This makes the average age of your credit accounts younger.

You could see your score go down as a result of having a shorter average credit age, although the specifics of the decline will vary based on many factors, including how long your credit history was in the first place.

Over time, however, your personal loan will become another older account on your credit record that actually helps your score — especially if you didn’t have any of these types of installment loans before (loans that you pay back with fixed payments). Revolving debt (like that on credit cards) has variable payments depending how much you’ve charged each month.

But despite the fact that the personal loan may benefit you over the long run by giving you another type of credit, your credit is likely to take a short-term hit.

You’ll develop a personal loan payment history

Finally, your personal loan will affect your credit either positively or negatively as you develop a payment history. If you pay your loan on time every month, this can help improve your credit since you’ll have a record of timely payments that future lenders can see. If you pay late, this can hurt your score because you will have a record of payments that are 30 or more days late (or, eventually, you could have a defaulted loan on your record).

Ultimately, while your credit score may decline in the short term due to a personal loan, if you borrow responsibly and pay your loan back on schedule, the loan could end up helping you in the long run.

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