This page may contain affiliate links. Read more here.

How do personal loans affect your credit score? Do they help or hurt? How before you see the impact and how long does it last?

Taking out a small personal loan is a good way to establish a record of on-time payment and build your credit history.

People with a poor score can rebuild their rating by paying off credit card debt or delinquent accounts – if they qualify.

The personal loan application process can both raise and lower your credit score. It all depends on what information shows up on your report and which agency displays the data.

Take responsibility for the outcome!

Small Personal Loans to Build Credit History

Taking out a small personal loan is one of the best ways to build a credit history. First-time borrowers need a starting point. Consumers with a record of late payments have to re-establish themselves as responsible payers or pay down debt.

Request a small personal loan online. Establish a record of fiscal discipline with each of the three major consumer reporting agencies. Improve your file in four major categories.

  1. Payment record (35%): make on-time monthly payments
  2. Amounts owed (30%): limit your borrowing
  3. Length of history (15%): start the clock ticking
  4. Diversity of accounts (15%): add an unsecured installment contract

No Credit Check

A no credit check credit builder personal loan can help consumers kick-start their record of borrowing money responsibly. Requesting a small amount makes it easier for the lender to approve the application and makes the payments more affordable.

  • No credit check online lenders do not pull reports from the big three bureaus. Instead, they work with alternative information providers to screen applicants. Small loan amounts make it safer for lenders to approve using less predictive data.
  • Low monthly payments are the key to gaining an approval without a credit check. The person must show the ability to repay the lender on time every period. The payment must be affordable relative to the monthly income. Small loans have low payments.

Credit builder loans may appeal to a variety of different neophyte borrowers.

Bad Credit History

Consumers with bad credit history can sometimes take out small personal loans to boost or rebuild their credit score. This strategy works only when the lender approves the request (rare), the person uses the money to improve their profile rather than continue spending (your call), and the small amount is sufficient for the task (uncertain).

  1. Do you qualify for debt relief? People with bad credit rarely find a willing lender – even at small amounts. However, borrowers who owe more than $10,000 often find that a settlement program is a better fit. A pattern of late payment actually motivates creditors to reach an agreement.
  2. If approved for the unsecured loan you should deploy the funding wisely. This means either paying off revolving debt or bringing delinquent accounts to a current payment status.

Paying Off Credit Card Debt

Approved personal loans can help consumers with low credit score boost their ratings by paying off existing credit card debt. The amount owed makes up 30% of the equation result. Converting revolving debt into an installment obligation alters the utilization ratio calculation.

  • Personal loans are unsecured installment contracts. They have fixed monthly payments and a defined original principal amount. The installment utilization ratio consistently declines as the account ages as per the amortization schedule.
  • Credit cards are the most common form of revolving debt. They have flexible monthly payments and account limits which can change over time. The revolving utilization ratio moves up and down over time as balances and limits fluctuate.

This is what happens initially to the utilization ratios when you pay off credit card debt.

  • The installment utilization ratio goes up. This lowers your rating a little because you have a new account appearing on your report and have yet to establish a record of on-time payment.
  • The revolving utilization ratio goes down. This often lifts your rating to a greater degree because people maxing out their spending limits have a riskier profile.

With debt consolidation, you still owe the same amount of money. Borrowing money to pay off credit card debt is a good idea only if you stop spending. You must steadily reduce obligations over time using the fixed monthly payments in order to improve your rating long-term.

Paying Off Delinquent Accounts

Approved personal loans can help consumers with bad credit history to boost their score by paying off delinquent accounts. Payment record makes up 35% of the equation result. Turning a major derogatory into a minor black mark can quickly improve qualifications.

People with delinquent accounts should keep these key considerations in mind.

  • Updating an account from “currently delinquent” to “paid as agreed” does not erase the negative past. However, it often results in a quick uptick in your ratings.
  • Ratings gradually improve over time as the late payment record grows older.
  • Negative information automatically ages from your consumer report 7 years after the date of first delinquency. Therefore, paying off newer items yields a better return.

Not every delinquent account appears on your consumer report and impacts your rating. Verify that the item appears on your file before borrowing money to pay them off.

  • Rarely Appear
  • Sometimes Appear
    • Medical bills
    • Collections accounts
    • Wage garnishment
    • IRS debt such as tax liens
    • Judgments
  • Always Appear
    • Mortgage arrears
    • Repossessed car
    • Defaulted student loans

How Applying for Personal Loans Affects Credit Scores

The way that applying for personal loans affects credit scores is an area of great concern and confusion. Some steps hurt while other help. Other times an application makes no difference.

The answer depends on what information appears on your consumer report, at which agency, and whether the data is helpful or harmful. Each situation is unique.

The five credit score factors come into play when applying. Be careful when buying a house.

Mortgage Application

Taking out a personal loan can also affect your mortgage application in three possible areas. Learn about these possible impacts if you are thinking about buying a house or just refinancing.

  1. A tri-bureau merged mortgage report selects the middle score. All of the factors noted above apply in this situation – except for the hard inquiry appearing at one bureau.
  2. The back-end debt-to-income ratio (DTI) will be higher and will impact your application. Mortgage lenders calculate two DTI ratios. The back-end number includes all obligations.
  3. Your down payment needs will be smaller and could help you avoid costly private mortgage insurance. Homebuyers can use the extra cash to get them to the coveted 20% figure.

Show on Report

Only the personal loan information that shows up on your credit report can affect your score. Every person has at least three different consumer files. The data that displays vary during the application, funding, and repayment phases.

Application Phase

A personal loan application may hurt your credit score slightly – but at only one bureau at most. The impact varies depending on where the lender turns for information during the underwriting process.

  • Soft inquiry means that the lender pulls an alternative data report to verify your identity, confirm employment, look for public records, or consider rental or utility payments. A soft pull does not show up on a big-three consumer bureau file because they did not provide any data. Therefore, soft inquiries do not harm your rating at these agencies.
  • Hard inquiries occur when a consumer initiates a borrowing application and the lender pulls a traditional consumer report. The one bureau providing the information logs the hard inquiry on its file. The bureau providing the data does not share the hard inquiry with the remaining agencies.
    • Hard inquiries display on only one of three bureau reports
    • Hard inquiries lower scores slightly for a short period
  • Declined applications do not hurt your rating. The lender does not communicate the declination to any of the consumer agencies. It does not show up in your file.

Funding Phase

An approved and funded personal loan will lower your credit score at the beginning. Shortly after you receive the money, the lender will report the new transaction to the bureaus. New borrowing activity makes up 10% of your rating.

Two pieces of information about your new account will display on your consumer report. This signals that you borrowed more money. Your rating will drop temporarily until positive payment information demonstrates that you can handle the new obligation. This lasts approximately 30 days until you make your first payment.

  1. Principal amount
  2. Open date
  3. Number of installments

Payment Phase

Your repayment record for a personal loan is the critical factor determining whether it helps or hurts your credit score over time. Payment record makes up 35% of your rating.

Payment status will appear on your consumer report 6 – 8 weeks after the loan funds and after the first payment due date. You need 6 months of history before seeing the result if this is your first account.

  • On-time payment raises
  • Late payments lower

The ratings rise with every on-time payment that you make. In addition, two other factors improve independently as the account grows older.

  • Length of history grows longer
  • New account activity becomes later