How Personal Loans Affect Your Credit Score

A personal loan can be a solution when you have emergency medical or car repair bills. You can also use one to consolidate other higher interest debt. Before you apply, understand how personal loans affect your credit score.

What Is a Personal Loan?

You can use the money for just about anything when you take out a personal loan. Most borrowers use personal loans to pay for emergency expenses, like medical bills. Others use them to pay off higher interest credit cards.

Why Take a Personal Loan?

If you have good credit, personal loans usually have lower interest rates than credit cards, allowing you to consolidate higher-interest debt into one lower-interest payment. You can also use a personal loan to make a major purchase at a lower rate than you’d pay using a credit card.

Personal loans also help you build a payment history and demonstrate that you are a reliable borrower who makes payments on time, improving a so-so credit score.

How Does a Personal Loan Affect Your Credit Score?

When you apply for a personal loan, most financial institutions will make a “hard inquiry” to credit reporting agencies (Experian, TransUnion, or Equifax). “Hard inquiries” may cause a temporary dip in your credit score because they signal that you need money.

Credit bureaus understand rate shopping, so if you apply for the same type of loan from several lenders within a short time, you won’t be penalized. However, if you apply for an auto loan, several credit cards, and a personal loan within a short time, that’s a red flag that you may be trying to take on more debt than you’ll be able to repay and could affect your credit score.

Other things that factor into how a personal loan affects your credit score are similar to those for any other form of debt. For example, if you miss a payment or are late, your score will go down.

One positive benefit is when you use a personal loan to pay off credit cards, you improve your “credit utilization ratio,” which is the amount of available revolving credit you’ve tapped. Personal loans are installment loans and don’t count against that ratio.

Taking a personal loan also improves your “credit mix” by adding an installment loan to a credit report that may also include revolving credit card debt.

A Word of Caution

If your credit isn’t so strong, you might pay a higher interest rate for a personal loan. Personal loans also often carry additional fees. And a personal loan will do you no good if you use it to pay off high-interest credit cards and then just run those cards up again.

If you’re exploring a personal loan option in Tennessee and you’re concerned about eligibility due to your credit score, contact Superior Financial Services. We may be able to help.

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