Does Applying For a Personal Loan Affect Credit Score?

If you’re thinking about applying for a personal loan, you might be wondering whether applying for a personal loan affects your credit score. We will answer this question in much detail below.

Does Applying For a Personal Loan Affect Credit Score?

Yes, applying for a personal loan does affect your credit score because when you apply for a personal loan, a hard inquiry is added to your credit report when the lender reviews your credit report. A hard inquiry can lower your credit score by a few points. So, a personal loan can lower your credit score regardless of whether you’re approved for the loan or denied since a hard inquiry is added to your credit report.

When you apply for a personal loan, your lender will want to review your credit report and take a look at your credit score to assess your creditworthiness in order to determine whether you’re likely to repay the loan as originally agreed. When a lender reviews your credit report, a hard inquiry is added to your credit report, alerting future lenders and creditors that you’ve been seeking to borrow money.

A hard inquiry from applying for a personal loan will appear on your credit report for 2 years from the date you applied for the personal loan. After the 2 year period, the hard inquiry will be removed from your credit report. That said, experts agree that a hard inquiry resulting from a personal loan application will only affect your credit score for 12 months from the date it’s added to your credit report. As the hard inquiry ages, its impact on your credit score will lessen.

If you’re applying for a personal loan, you likely cannot avoid a hard inquiry because lenders will want to review your credit report to determine whether to lend you money. That said, a hard inquiry will only lower your credit score by just a few points, so it might be worth it for you to apply for a personal loan. That said, you should avoid applying for too many personal loans within a short period of time, because each time you apply, a hard inquiry is added to your credit report.

You should avoid submitting too many personal loan applications and other credit applications because although a single hard inquiry is unlikely to cause a big drop in your credit score, submitting too many applications within a short period of time can significantly lower your credit score.

Can a Personal Loan Raise Your Credit Score?

Yes, if used properly, a personal loan can definitely affect your credit score positively and raise it. For example, if you make all of your personal loan payments on time, this will boost your credit score. This is so because your payment history accounts for 35% of your credit score, so making timely payments will affect your credit score positively, raising it.

Additionally, if you use the proceeds from a personal loan to consolidate your debts by paying off other loans and credit cards, you could see a substantial boost in your credit score. Personal loans are often used to consolidate credit card debts because they have a lower interest rate than credit cards, allowing you to pay down your balances faster since less money is wasted on interest. Whenever you decrease your account balances, your credit score improves. This is so because your credit utilization accounts for 30% of your credit score. So, using the proceeds to pay down your debts faster can improve your credit score.

Furthermore, a personal loan can improve your credit score because it improves your credit mix, which refers to the diversity of debt products that you’re using. Your credit mix is factored into your credit score and accounts for 10% of your credit score. So, a personal loan can improve your credit for this reason.

Can a Personal Loan Lower Your Credit Score?

Yes, a personal loan can lower your credit score for a variety of reasons that we will explore below:

First, a personal loan can lower your credit score by a few points because, as mentioned above, a hard inquiry is added to your credit report whenever you apply for a personal loan which is customary when a lender reviews a copy of your credit report for lending purposes. That said, a hard inquiry will only knock down your credit score by a few points, and your credit score will quickly recover soon thereafter.

Second, the status of your personal account is reported to the credit reporting bureaus. If you fail to make your payments on time, you could cause significant damage to your credit score. So, to avoid damage to your credit, you should make all of your payments on time.

Third, if you’re taking out a personal loan for a purpose other than consolidating your debts or paying them off, you may cause a drop in your credit score because taking on debt increases your account balances, which is factored into your credit score.

Things You Should Consider Before Applying For a Personal Loan

Let’s explore some things that you should consider before applying for a personal loan:

1. Getting into more debt – Before applying for a personal loan, you should think hard about whether you want to get yourself into debt. If you want to take a vacation and need the funds to finance it or want to make an expensive purchase, you should really think about whether you want to get yourself into debt to do so. It might be worth it for you to save up for the item you want to purchase instead of locking yourself into monthly payments for years to come.

2. Interest Rate and Fees – Before taking out a personal loan, you should consider whether your credit score qualifies you for a reasonable interest rate. You should make this consider because if your credit score is low, you may still be approved but at an astronomically high interest rate, which will cause you to have to pay back much more than what you borrowed. So, consider the interest rate you may qualify for before applying.

3. DTI – Before applying for a loan, you should consider your DTI (debt-to-income) ratio. As a rule of thumb, you want your debt to income ratio to be less than 43%. Typically, the higher your DTI, the less likely it is that you’ll be approved for a personal loan, and if you’re approved, you might be approved at a very high interest rate.

4. Consider you options – Before settling on a personal loan to apply for, you should shop around and research the personal loan that you want. Consider the rates typically offered by lenders and search for one that has the lowest interest rate and most favorable repayment terms.

If after considering these factors you decide that applying for a personal loan is the right move for you, you should review your credit report and credit score to see the impact the personal loan had on your credit. There are plenty of apps and websites that provide you with the ability to check your credit for free.

Frequently Asked Questions (FAQs)

1. Why does applying for a personal loan lower your credit score?

Applying for a personal low may lower your credit score by a few points because when you apply and a lender reviews a copy of your credit report, a hard inquiry is added to your credit report, slightly lowering your credit score.

2. Does applying for a personal loan result in a hard inquiry?

Yes, applying for a personal loan results in a hard inquiry that will remain on your credit report for 2 years, after which it’s automatically removed from your credit report.

3. How long does a declined loan stay on your credit file?

A hard inquiry resulting from a declined loan application will remain on your credit file for 2 years from your application date. After the 2 year period, the hard inquiry is automatically removed from your credit report.