How does a personal loan affect your credit score?
Personal loans are capable of affecting your credit score. However, the way in which they affect your credit score is totally dependent on you.
If you take out a personal loan and pay it back on time and perfectly throughout the term of the loan then it can have a positive impact on your credit score. However, if you take out a personal loan and default on it, or miss payments, it will affect your credit score negatively.
Building a positive credit score is something many people want, especially those who want to improve their credit score after chapter 13. However, there are many ways that you can get a more positive credit score. It all depends on how you manage your credit and debts.
So, let’s look into how a personal loan may affect your credit score, and what actually does affect your credit score overall.
What things factor into your credit score
Before we jump into the specifics of personal loans, let’s take a look into what actually contributes to your credit score.
The most used score lenders use is the FICO score, these scores will range from 300 to 850. We need to understand how this is calculated.
Your FICO score will be figured out using amounts owed, new credit, payment history, the length of credit history, and also if you have a mix of credit.
There are 3 rating agencies, and between these the percentages that each factor will be worth may vary. However, as a guideline, we would anticipate it would look something like this:
- Previous payments make up for 35%
- Amount of outstanding debt makes up for 30%
- Credit history length makes up for 15%
- New debt/ Credit lines makes up for 10%
- Having a mix of credit makes up for 10%
These are not perfect numbers but work as a good guideline.
Does applying for loans affect credit scores?
This does mean that if you take out a new personal loan it does have the potential to have an effect on your credit score. By how much will vary. This is because it increases outstanding debt as you have acquired a new debt.
All credit agencies will note any financial activity that takes place. So if you took out an auto loan not long after having taken out a personal loan, the auto loan could be rejected on the promise that you already have as much debt as you could reasonably handle.
However, the state of your credit history will hold much more significance than simply taking out just one new loan.
Therefore, if you have a history of managing your debts well and making payments on time then how much your credit score will be impacted by new debt will be less significant.
So, to prevent your debt from lowering your credit score overall, you should be making payments on time and as per agreement with the lender. Do this, and you should be totally fine and taking out new debt should not be an issue, especially in the long term.
Can personal loans boost your credit score?
Personal loans can have effect your credit score positively, however, that is more dependent on you. If you repay the loan in a timely fashion and as is expected by the lender then this will have a positive effect.
Paying back a loan on time and as agreed shows that you are able to handle debt with responsibility and that you are a responsible person.
Ironically, those who are more likely to take on debt are also the ones who have the worst credit scores.
Whether or not a personal loan will have a good or bad effect on your credit score all depends on your ability to pay back the loan.
Do not forget that the positive effect from paying back on time will not have an immediate effect. To wit, if you make a few payments on time, do not expect to see good results on your credit score after just a few months.
If you pay the WHOLE loan off in a timely manner, then you will see a boost in your score, not before.
What kind of credit score do you need for a personal loan?
This all being said, not anyone can just go ahead and grab a personal loan. Credit scores have an effect on your ability to take out the loan in the first place.
FICO credit scores range from 300 to 850 and the higher your score is the more likely you are to get the loan, and get a lower interest rate as well. This is simply because the higher number the score is, the more reliable you are seen as a borrower.
Every lender will have their own criteria of what is considered to be a good credit score, and each will have a cap on how low they are willing to go.
Generally a credit score of 670 is accepted by most lenders.
Note the following;
- A credit score of 580 or less is seen as a risky borrower.
- A credit score of 580 to 669 is below average but may still get approval.
- A credit score of 670 to 739 is seen as just above average and will be seen as good.
- A score of 740 to 799 shows the borrower is dependable, this is favorable.
- 800 and above is excellent and is viewed as exceptional. You will easily get a loan with this credit score.