Applying for a personal loan can affect your credit score. However, it is only one of several factors which can contribute to lower or increase your credit score. Your FICO credit score is affected to a much greater extent by your payment history, credit history, and the total amount of your debt. The effect of loan applications on your credit score can be minimized by applying only an as-needed basis and by ensuring that you are in a financial position to meet or exceed the eligibility requirements to be approved for a loan. If you are considering applying for a personal loan, you may wonder if the application process itself can have a negative impact on your credit score, making it more difficult to obtain the loan or to shop around for the best rate. The good news is that while applying for a personal loan can affect your credit score, this effect is quite minimal compared to other factors.
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What Determines your Credit Score
There are several factors that lenders take into account when determining your eligibility for a loan. When you apply for a personal loan, your potential lender will look at your credit score, or FICO score, to determine your past credit history, and whether you are likely to default on a loan. Your credit score is based upon an algorithm used by credit reporting agencies that takes into account your credit history. There are three main credit reporting bureaus that lenders typically use: Experian, Equifax, and TransUnion.
Your FICO score is the most popular credit score for determining eligibility for a loan, and this can be different for each of the major credit reporting bureaus. The purpose of your credit score is to help lenders get a general idea of how likely you are to repay your debt.
- 35% of your credit score is based upon your payment history. Missing payments or defaulting on loans will negatively affect this part of your credit score. Alternatively, making timely payments, and avoiding defaulting on loans increases this aspect of your credit score.
- 30% is based on your total debt. Lenders want to be sure that you aren’t “maxed out,” and that you can afford to make the payments on an additional loan.
- The length of time that you have had a credit history makes up 15% of your credit score. If you have had a long history of making timely payments, this will positively affect your credit score.
- 10% of your score is based upon the types of debt that you have had in the past, and a healthy mix of auto loans, credit cards, and other types of loans can positively impact your credit score.
- The final 10% of your credit score is based upon new inquiries, and if you have applied for numerous loans in the recent past.
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How Applying for a Personal Loan Can Affect your Credit Score
While it is not the most important factor that contributes to your credit score, applying for a new personal loan will affect your credit. It is important to note that any “hard” loan inquiries affect your credit. These are inquiries for which you submit an application, and these will remain on your credit report for two years, and can affect your credit score for twelve months after submitting the inquiry. Fortunately, multiple inquiries over a short period regarding certain loans such as auto loans, student loans, and mortgages will be treated as a single inquiry, and will have minimal impact upon your overall credit score. Most lenders are aware that these multiple inquiries are the result of rate shopping by consumers in an effort to find the best rate.
Depending on the credit reporting bureau, loan inquiries made within 14 – 45 days of one another are treated as a single inquiry in order to allow borrowers to shop for the best rate. While it is a good idea to shop around for the best rate, it is important to keep in mind that every time you apply for a loan, this will impact your credit score, so be sure to apply only for loans that you are seriously considering. Additionally, being rejected for a loan will negatively affect your credit score, so it is strongly recommended that you double-check to ensure that you meet the basic eligibility requirements, and that you are in a strong financial position to qualify for the loan for which you are applying.
How to Improve your Credit Score
Applying for a personal loan can affect your credit score; however, you can take measures to ensure that you have a good credit score. Making timely payments and avoiding defaulting on your loans are the most important things that you can do to ensure that you have a good credit score. Additionally, keeping your balance low on credit cards and other revolving forms of credit will contribute to a higher credit score. You should only apply for a new loan as needed, and only if you are in a financial position to meet or exceed the eligibility requirements of the lender.
