Does applying for a personal loan hurt your credit score?

When you apply for a personal loan, lenders must perform a hard credit check to view your credit file. This will cause a temporary drop in your score of a few points. That’s why it’s important to start the shopping process by choosing lenders that allow prequalification, which doesn’t affect your scores.

Like any type of loan, personal loans can do damage if you don’t make your payments on time. On the other hand, using personal loans for debt consolidation can give your score a major boost, especially if you use them to pay off revolving credit accounts (like credit cards).

How personal loans could hurt your credit

Personal loans could potentially lower your credit score in several ways. Making regular, on-time payments will help you avoid major damage.

Hard inquiry on your credit

Since hard inquiries related to new credit only make up about 10 percent of your credit score, the drop usually doesn’t amount to more than a few points. However, it is very important not to authorize multiple credit checks within a 12-month period. Otherwise, the negative effect on your credit could be more substantial. If you need to apply with several lenders at once to compare rates, keep your applications within a two-week period, so the inquiries count as one.

Bankrate tip:

Don’t authorize a hard inquiry for your personal loan application until you’ve shopped at several lenders and chosen the one that meets your needs. Most lenders will prequalify you without a ding to your credit. You can get several prequalified offers from multiple lenders by applying on a marketplace lending platform like Bankrate.

Shortens your credit history

Since length of credit history accounts for 15 percent of your FICO score, opening a new loan account can lower the average age of your credit. This could result in a small dip in your score that will correct itself the longer you have the new account. However, the negative effect could be more pronounced if you use your new personal loan to pay off — and close out — several older accounts.

Late or missed payments

Like most other types of debt, a late payment of 30 days or more could result in a negative report to one or more credit bureaus. The late payment can take approximately seven years to fall off your credit report and will ding your score. If enough time has passed and the account goes to collections, your credit score could drop between 90 and 110 points.

How personal loans could help your credit

When used responsibly, a personal loan can positively impact your credit score in a few ways, like improving your credit mix and boosting your payment history.

Reduces your credit utilization ratio if you use it to consolidate debt

Your credit utilization ratio accounts for 30 percent of your FICO score and measures how much available credit you’ve used on revolving cards like credit cards. A personal loan is an installment loan with a fixed monthly payment paid on a set schedule. Taking out a personal

Using a personal loan to consolidate debt, especially credit card debt, may lower your credit utilization ratio, giving your credit score a nice boost. However, there’s a catch: you have to avoid or minimize your credit card use in the future. The positive effect of clearing out your credit card balances will be undone if you start maxing out credit cards in the future.

Provides a better credit mix

Although credit mix only accounts for 10 percent of your FICO score, adding a personal loan could help your credit mix if you don’t have any other installment loans. It is generally a good idea to have a mix of installment loans and revolving credit.

Boosts your payment history

Making payments on time has the biggest impact on your credit score, so adding a personal loan you pay on time could help you establish a positive payment history. Another benefit of consolidating multiple credit cards with a debt consolidation loan, is you lower the risk you might miss a payment because you’re juggling so many different due dates.

How to use a personal loan to improve your credit

We touched on this above, but it’s worth repeating: using a personal loan to pay off credit card debt could be a fast path to a much higher credit score.

Bankrate’s recent credit utilization survey found that nearly 2 in 5 cardholders have maxed out a credit card since the Fed started hiking rates. A maxed-out card can have devastating, immediate effects on your credit scores.

However, once they’re paid off, your scores can increase just as quickly, as long as you avoid future excessive credit card use, make your payments on time and avoid opening multiple accounts in a short period of time.

Bottom line

Personal loans can be a great tool to help you improve your credit score over time — once you get past the temporary inquiry blip when the lender finalizes your approval. The benefits of using a personal loan to pay off revolving debt usually far outweigh the hard inquiry drop. However, the payment is fixed, which means you won’t have the flexibility of a minimum payment like you do with credit cards. Use a personal loan calculator to preview your payment amount so you avoid committing to an unaffordable fixed payment you’ll typically have for one to seven years.