Would Personal Loans Help or Hurt Your Credit Score? This is the question we have answered in this article today. If you are facing some of life’s biggest expenses, such as a home renovation, a medical bill, an emergency, a wedding, or even a funeral, but find yourself short on the cash needed to cover these costs right away. You have a really good solution in this article.

In such situations, a personal loan can be a valuable form of credit that can come to your rescue. However, before you decide to take on this additional debt, it’s crucial to understand how it can affect your credit score.

In this comprehensive guide, we will explore the impact of personal loans on your credit and provide insights into their potential benefits and drawbacks.

How Personal Loans Can Impact Your Credit

When it comes to paying for significant expenses, personal loans offer a convenient solution. According to a 2019 Experian study, personal loans are the fastest-growing form of debt in the United States. However, before jumping into a personal loan, it’s crucial to consider how it can impact your credit score.

Why Use a Personal Loan in the First Place

Personal loans provide an appealing option for financing large expenses due to their relatively lower interest rates compared to credit cards. The Federal Reserve states that the current average APR for a two-year personal loan is 9.58%, while credit cards can have an average interest rate of 16.30%, which can even reach up to 24%. By opting for a personal loan, you can save money on interest and effectively cover significant expenses or consolidate existing debts.

How Personal Loans Can Help Your Credit Score

One of the ways a personal loan can positively impact your credit score is by improving your credit mix. Your credit mix represents the variety of credit accounts you have, such as credit cards, loans, and mortgages.

It constitutes 10% of your credit score. Having a diverse range of accounts demonstrates to lenders that you can effectively manage different types of credit, enhancing your creditworthiness when applying for new forms of credit, like mortgages or car loans. It’s essential, however, to ensure that you don’t take on excessive debt.

Additionally, personal loans allow you to establish a track record of making on-time payments, which is the most critical factor in calculating your credit score, accounting for 35% of it.

Consistently paying your monthly installments on time indicates to lenders that you are a responsible borrower who is likely to repay future loans diligently. This aspect holds particular significance when you are in the process of building or improving your credit.

Even if you have fair or bad credit, certain lenders offer personal loans tailored to your situation, allowing you to take steps toward financial stability.

Personal Loans for Building Credit

If you have a credit score of 600 or below, or if you have insufficient credit history to even have a credit score, there are still options available for obtaining a personal loan. Lenders like Upstart and OneMain Financial offer personal loans specifically designed for individuals with fair or poor credit.

These loans provide an opportunity to demonstrate responsible financial behaviour and improve your credit score over time. However, it’s important to note that loans for individuals with lower credit scores may come with higher interest rates and additional fees.

Personal Loans for Fair or Bad Credit

Upstart Personal Loans and OneMain Financial Personal Loans are two examples of lenders that offer personal loan options for individuals with fair or poor credit. Upstart allows applicants with a credit score of 600 or below, and OneMain Financial considers individuals with poor or fair credit.

Before applying, it’s essential to understand that taking on a personal loan with poor credit may result in higher interest rates and additional fees. Make sure to review the terms and conditions before proceeding.

Upstart Personal Loans

• APR: 4.60% – 35.99%
• Loan Purpose: Debt consolidation, credit card refinancing, wedding, moving, or medical expenses
• Loan Amounts: $1,000 to $50,000
• Terms: 36 and 60 months
• Credit Needed: FICO or Vantage score of 600 (applicants with insufficient credit history accepted)
• Origination Fee: 0% to 12% of the target amount
• Early Payoff Penalty: None
• Late Fee: The greater of 5% of the monthly past due amount or $15

OneMain Financial Personal Loans

• 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 $100 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% (depending on your state)

It’s advisable to check if you prequalify for a personal loan offer from these lenders to gain a better understanding of the terms and rates available to you.

How a Personal Loan Can Hurt Your Credit Score

While personal loans can offer many benefits, it’s important to understand that irresponsible use of these loans can have a negative impact on your credit score. Similar to any other form of credit, applying for a personal loan results in a hard inquiry on your credit report, which can cause a slight dip in your credit score. Each hard inquiry stays on your credit report and affects your score for a certain period.

To mitigate any negative impact, it’s advisable to be strategic when you apply for a personal loan. Applying for a personal loan immediately after applying for a new credit card, for example, can result in a more significant drop in your credit score, as both applications will trigger hard inquiries.

Many lenders provide online tools that allow you to estimate the interest rate you’re likely to qualify for based on your information. These pre-qualification tools do not harm your credit score, enabling you to make an informed decision about the best interest rate before submitting your loan application.

Strategic Timing for Personal Loan Applications

Timing is crucial when it comes to personal loan applications. If you’re planning to apply for a personal loan, it’s wise to avoid multiple credit applications within a short time frame. Spacing out your applications can help minimize the impact on your credit score.

Additionally, it allows you to carefully assess your financial situation and determine the best time to take on additional debt. Remember, responsible financial management includes thoughtful planning and consideration of your current and future financial obligations.

Responsible Use of Personal Loans

While personal loans can be helpful for various purposes, it’s important to be mindful of your financial habits to ensure that a personal loan doesn’t become an additional burden.

For example, if you use a personal loan to pay off a maxed-out credit card but then immediately max out the credit card again, you’ll be left with both credit card debt and a personal loan to repay.

This debt cycle can have a negative impact on your credit score, especially if you struggle to make timely payments or fail to pay the full amount owed. It’s crucial to have a solid plan in place to pay off any additional debt before applying for a personal loan.

Furthermore, addressing the root causes of unhealthy financial habits can help you tackle the underlying issues rather than simply managing the symptoms.

Personal Loans for Debt Consolidation

One popular use of personal loans is debt consolidation. If you have multiple debts with varying interest rates, consolidating them into a single personal loan can simplify your finances and potentially reduce the overall interest you pay. By consolidating your debts, you can focus on repaying a single loan, making it easier to manage your payments and stay on track.

When considering debt consolidation through a personal loan, it’s important to compare interest rates, terms, and fees from different lenders. By doing so, you can find the most favourable loan option that suits your financial needs.

Avoiding Debt Cycle with Personal Loans

To prevent falling into a debt cycle, it’s crucial to use personal loans responsibly. Carefully consider your financial situation, make a budget, and assess your ability to repay the loan before taking on additional debt. By having a clear repayment plan in place, you can avoid accumulating more debt and protect your credit score.

The Bottom Line

In conclusion, personal loans can be an affordable and convenient option for funding significant expenses, managing emergencies, or consolidating debt. Their impact on your credit score depends on how responsibly they are used.

While applying for a personal loan may result in a temporary dip in your credit score due to a hard inquiry, using a personal loan to diversify your credit mix and consistently making on-time payments can have a positive effect on your credit score.

However, it’s essential to be cautious and avoid excessive debt or falling into a debt cycle. Responsible use of personal loans, coupled with healthy financial habits, can help you effectively manage your credit and achieve long-term financial stability.

FAQs (Frequently Asked Questions)

1. Can taking on a personal loan improve my credit score? Yes, taking on a personal loan can positively impact your credit score. It can help diversify your credit mix and establish a track record of making on-time payments, both of which are factors that contribute to a higher credit score.

2. Can I get a personal loan with bad credit? Yes, some lenders offer personal loans specifically designed for individuals with fair or poor credit. While the interest rates and fees may be higher, these loans provide an opportunity to rebuild your credit score over time.

3. Will applying for a personal loan hurt my credit score? Applying for a personal loan will result in a hard inquiry on your credit report, which may cause a slight dip in your credit score. However, the impact is usually temporary, and with responsible financial management, your score can recover and potentially improve.

4. How should I time my personal loan application to minimize the impact on my credit score? To minimize the impact on your credit score, avoid applying for multiple credit products within a short period. Spacing out your applications and carefully considering your financial situation can help mitigate any negative effects on your credit score.

5. What should I consider before taking on a personal loan? Before taking on a personal loan, it’s important to assess your financial situation, create a repayment plan, and ensure that you can comfortably manage the additional debt. Consider the interest rates, terms, and fees offered by different lenders to find the most suitable option for your needs.

Remember, it’s always advisable to consult with a financial advisor or credit counsellor to get personalized advice based on your specific circumstances.