A personal loan (or any form of loan) can hurt your credit if you don’t manage it properly. However, a responsibly handled personal loan can certainly help and promote long-term credit score improvement. This will depend on a few factors, like your other debts and your credit history, which we will break down today.
Tonawanda Valley Federal Credit Union is always looking to help our fellow Batavia and Genesee County residents build their financial worth! Personal loans are a big aspect of how we do that, and today on the blog, we figured we would help break down a few ways that loans will affect your credit. As you may or may not know, we have now expanded our field of membership into 13 other counties! This means if you (or someone in your family) are in one of the counties listed on our field of membership page, you can apply for a personal loan with us through our Batavia branch!
Let’s get down to business and help you understand how a personal loan will affect your credit.
What’s a Personal Loan?
A personal loan can be taken out for just about any reason, except for things like college tuition, gambling, or a down payment on a mortgage. Of course, the lump sum of cash you borrow will need to be paid back, along with interest and fees, over the course of a set amount of time.
Mortgages and auto loans are known as “secured debts” because they are backed by collateral like a house or vehicle, whereas most personal loans are considered “unsecured debts.” This creates a higher interest rate than other secured credit, but also offers typically lower APRs than a new credit card.
Will Applying Affect Your Credit?
An application for a personal loan will trigger what is known as a “hard inquiry,” which will cause a small, short-lived decline in your overall credit score. This is similar to applying for a credit card. When you are approved for a personal loan and receive the loan, don’t be surprised when your credit score may drop a few more points. This is because the new credit line decreases the overall age of your accounts. This doesn’t mean that personal loans are BAD for your credit, though!
Here is why.
Personal Loans CAN Help Your Credit
When handled responsibly, a personal loan on your credit can help to improve your score.
Positive Payments
About 35% of your FICO® credit score is influenced by debt payment history. This is the greatest influence you can have on your score. Every time you make an on-time payment on your personal loan, you add to your positive payment history, which helps to promote credit score improvement.
You don’t want to be late on your payment! Any payment later than 30 days or more can do serious harm to your credit score.
Lower Credit Utilization
Credit utilization is responsible for roughly 30% of your FICO® score. By reducing other debts to use a personal loan for credit card debt consolidation, you could improve your credit score. This is because by reducing your overall credit card balances, you reduce the percentage of available credit you are using. So using a personal loan to pay down higher-interest credit card debt could be a good idea if you can make the payments. You can save yourself from paying more interest in the long run as well.
If you use more than about 30% of your credit available, you could significantly damage your score.
Diversify Credit Mix
About 10% of your FICO® credit score is made up by what’s called your “credit mix.” Lenders (like us) like to see evidence of a borrower who has a healthy mix of installment loans and revolving credit. This means multiple accounts and different types of debt. A personal loan can increase the number and type of active credit accounts. If all you have are credit cards, it could help improve your score by enhancing your credit mix.
How to Avoid Hurting Your Credit Score with a Personal Loan
Any debt is a risk, especially if you mismanage it. Here’s how to avoid a personal loan hurting your credit.
Mishandling New Payments
Regardless of any other debts you have, taking a personal loan out is a new responsibility in the form of an additional monthly payment. This may affect your lifestyle and budgeting. If you fail to make a payment or make a payment late, you could get hit with more than a late fee. Late payments or missed payments can significantly hurt your payment history and thus, your credit scores. Using autopay is a great way to never forget you have a new personal loan payment.
Shopping Multiple Hard Inquiries
Before you start applying for any available personal loan or credit card, you’ll want to do your homework beforehand. Know where you want to apply and avoid triggering multiple hard inquiries with multiple credit card applications in a short timespan. This can have a negative effect on your credit.
Ultimately, the hard inquiry is not something you can control, as you’ll see a quick dip in your score once you apply. As mentioned above, you may see the new loan dip your score a few points when the loan is issued, but these drops will improve once you start making on-time payments regularly.
Improperly Using New Debt
If you plan to consolidate debt using your personal loan, you’ll want to do it quickly. When you take out a personal loan, it will add to your overall debt load. This can have a negative impact. However, you can offset the total debt by using some or all of the borrowed funds to consolidate other loan or credit card accounts. This eventually does lead to a score improvement, but it may just take a month or two to demonstrate. Regardless of whether you plan to use the loan to offset other debts, regular payments on your loan and other debts will slowly build your score.
Are You Looking for a Personal Loan in Batavia or Western New York?
If you’re considering borrowing a personal loan, we highly recommend you consider TVFCU. Credit unions often can provide competitive interest rates, and being owned by the community, they have unique benefits. Credit unions also often have less rigorous lending requirements than traditional banks. If you’d like to speak with someone from TVFCU about your financial situation, please don’t hesitate to give us a call at (800) 722-8224, or stop down and see us in Batavia at 10 Jefferson Square! We look forward to meeting you!
