Do personal loans affect credit scores? Like any other form of financing, they can help or hurt ratings – depending on how the borrower behaves over time.
Soft inquiries allow people to shop around for personal loan interest rates without affecting their credit score. The same holds for no credit check options.
However, everything changes once somebody decides to take out a personal loan. The lender will report the activity to the three consumer reporting agencies.
- How to shop around for interest rates
- Factors helping and hurting ratings
- Impact of credit card consolidations
- Effect on mortgage applications
Shopping Personal Loans Won’t Affect Credit Score
Shop around for personal loans in a way that will not affect your credit score. Most borrowers have several avenues to compare interest rates, origination fees, and monthly payment offers from various lenders – without having a hard inquiry appear on their report and hurting their ratings.
Start a personal loan request here. A single soft inquiry will not affect your credit score, but multiple hard inquiries will. Therefore, submitting a single request that reaches a network of possible lenders helps preserve your borrowing qualifications.
Personal loan companies using soft inquiries will not affect credit scores during the prequalification stage. A soft credit check can occur in one of two ways.
- The consumer pulls his or her own file for an updated credit score, which generates a soft inquiry. The consumer inputs the updated rating and other qualifications into the online personal loan interest rate estimator.
- An intermediary agent separates financial and identifying information and presents the qualifications only data to a network of personal loan lenders. Since the lenders never see any identifying information, the bureau logs a soft inquiry on the person’s file.
Keep in mind two things that can happen after the prequalifying soft inquiry.
- The individual decides to follow through and complete an application from his or her chosen lender. The lender will pull a copy of the consumer report, and the bureau providing the file will log a hard inquiry.
- If the individual borrows money, the personal loan will show up on his or her credit report. This most certainly will impact ratings – see more below.
No Credit Check
Personal loans with no credit check also do not affect your credit score during the prequalification stage. The lender does not pull a copy of your consumer report when making an underwriting decision. Therefore, the initial process does not result in a hard inquiry on your file.
Once again, keep in mind what happens after the company makes an underwriting decision without a credit check. If the individual borrows the money, the personal loan will show up on his or her credit report. This also impacts ratings – see more below.
When Personal Loans do Affect Credit Scores
Taking out a personal loan will affect credit scores for a simple reason. It will show up on your consumer report about 45 days after the money disburses to your bank account.
Having a personal loan appear on a consumer report can either help or hurt ratings. The result is different for every individual and every situation.
Request a small personal loan to build credit score if you have a short history or lack diversity in your account mix. Make each monthly payment on time to build a solid history.
A small personal loan will influence each of the five main factors making up the average borrower’s FICO score as depicted in this chart.
- Length of history 15% and new borrowing 10% will improve as the account ages
- Types in use 10% will improve if this is your first installment contract
- Amount owed 30% is minimized by requesting a small amount
- Payment history 35% is helped by staying current at all times
Young adults and first-time borrowers often find that credit builder loans with no credit check help them to establish a history of on-time payment. Requesting small amounts is the key to obtaining an approval, and having a manageable monthly payment.
Taking out a personal loan will hurt credit scores if the borrower cannot afford the monthly payment and falls behind. Late payment will adversely impact ratings – just like with a delinquency on a credit card, car financing, or mortgage.
The negative personal loan payment information will display on your consumer report and hurt ratings for a long time.
- Derogatory data reported by the original lender disappears seven years after the date of first delinquency.
- If a collection agency takes you to court and wins a lawsuit, the public record will also display. Judgements and liens disappear seven years after the court filing date.
The severity of personal loan payment delinquencies also hurts ratings differently. A 30-day late does less damage than a charge-off, collection account, or a public record resulting from a lawsuit.
Credit Card Debt
Taking out a personal loan to pay off credit card debt is a good idea if the borrower keeps the revolving balances down permanently. However, far too many people make it temporary – which is a very bad idea.
Debt consolidation typically does not affect credit scores at the beginning – as the plusses and minuses cancel each other out. However, the real impact comes years later. Which scenario describes you?
Revolving vs Installment
First, consider the impact of personal loan amounts vs credit card balances on credit scores at the beginning of the debt consolidation process. The borrower still owes the same amount of money. However, the account types are different.
- Credit cards are revolving contracts. Revolving accounts have flexible monthly payments terms and indefinite repayment timeframes.
- Personal loans are installment contracts. Installment accounts feature fixed monthly payments and finite repayment terms.
Credit scores calculate two utilization ratios. A low percentage raises ratings, while a high percentage lowers them. One ratio improves while the other degrades when you consolidate credit card balances using a personal loan.
- Total utilization ratio climbs with new installment contracts
- Revolving utilization ratio drops as credit card balances move to zero
Personal loan interest rates are often lower than for credit cards. The interest savings from debt consolidation can reduce the amount owed over time. Since the amount owed makes up 30% of the average credit score, the savings can lift ratings.
However, the opposite is also true.
Transferring revolving balances to an installment contract frees up open to buy. Open to buy allows people to resume credit card spending after the transfer. Far too frequently, these borrowers find themselves in more trouble than before. Now they owe twice as much money!
An eventual increase in the amount owed hurts ratings.
Taking out a personal loan can also affect your mortgage application in three possible areas. Pay close attention to the potential influence on your credit report and score, debt-to-income ratio, and down payment.
Mortgage loan applications also consider the size of the down payment. The down payment is a critical variable in the Loan-To-Value (LTV) ratio. A large deposit pushes the LTV lower, which improves qualifications.
Using a personal loan as a down payment for a mortgage is very tricky. The underwriters prefer to see borrowers who self-fund their down payment. A large deposit into a savings account is a red flag – especially when it occurs around the closing.
Most mortgage applications utilize a tri-bureau merged consumer report and a specialized mortgage overlay credit score. A personal loan will appear on the merged file and influence the overlay rating in the manner already described based on the five key factors.
- Length of history
- New borrowing activity
- Types of accounts
- Amount owed
- Payment history
Mortgage applications also consider the borrowers proposed Debt-To-Income (DTI) ratio. The underwriter calculates DTI by dividing the projected monthly payments by the expected monthly income. Two ratios are important.
- Front-end DTI includes monthly payments of the mortgage principal, interest, real estate taxes, and homeowner’s insurance premiums
- Back-end DTI combines the front-end fraction with all other monthly obligations including car notes, credit cards, and unsecured installment contracts
Taking out a personal loan increases the monthly payment figure in the numerator of the back-end DTI. This pushes this percentage higher, which hurts the mortgage application.