How Personal Loans Can Hurt or Improve Your Credit Score

When taking on additional debt, like a personal loan, you should consider how new credit can affect your finances. 

It can be a lifesaver if you don’t have enough cash. It can also result in a better credit score if you do it right. But if mismanaged, the repercussions can harm your finances. 

So does a personal loan affect your credit score positively or negatively? Keep reading to learn the answer. 

Does Applying for a Personal Loan Affect Credit Score?

Yes, it does. Applying for a personal loan may cause your credit score to drop slightly, but only temporarily. Since payment history is a significant component of your credit score, you can improve your credit score over time by making timely payments. 

Your credit score is also calculated based on factors such as credit utilization ratio, length of credit history, type of credit, and new credit.

Just how much does a loan affect your credit score? Learn more below.

How Does a Personal Loan Improve Your Credit Score? 

A personal loan can affect your credit score positively, provided that you show your ability to manage debt.  

👍 Build Payment History 

Lending institutions want to know whether you can pay back any money you borrow. When you pay your loan on time and in full every month, it establishes a good payment history. This improves your credit score.  

👍 Diversify Credit Mix 

Aside from revolving credit from your credit cards, installment credit—like a personal loan—enhances your credit mix. Having a bit of variety in your credit history helps boost your credit score because it demonstrates how you manage different types of debt. 

👍 Reduced Credit Utilization Ratio

Credit utilization ratio refers to the percentage of your total available credit currently being used.^[2] Because it’s different from revolving credit in that you pay it in monthly installments, a personal loan doesn’t affect your credit utilization ratio.

In fact, a personal loan can boost your credit score if you use it for credit card debt consolidation. 

How Does a Personal Loan Hurt Your Credit Score?

Do personal loans hurt your credit? They can—if you misuse them. 

👎 Multiple Hard Credit Checks

Lenders will check your credit report before you get approved or declined. Banks and credit agencies perform a hard credit check to obtain your full credit report from a credit bureau.^[1] Credit bureaus get your information from your current and past creditors to assess your financial health and creditworthiness. 

These hard credit checks will appear on your credit report and cause a dip in your credit score. Thus, too many hard credit checks in a short period will negatively affect your credit score. Moreover, lenders can flag it as a sign that you need money desperately. 

Plus, a personal loan increases your debt, another factor that makes up your credit score. Applying for another loan after recently getting one from another lender also raises the possibility of getting denied because it can be too much debt for you to handle. 

👎 Missed Payments  

Credit reporting agencies record your payment history, so any late payments on your loan will reflect on your credit report and negatively impact your credit score. 

A one-time late payment may be viewed as a minor indiscretion. But lenders will see consistently late payments as a red flag, thus ruining your chances of getting approved for credit again in the future. 

Related: Personal Loan Fees: How Much Does It Cost to Borrow Money?

How to Manage a Personal Loan to Avoid Hurting Your Credit Score

Responsible personal loan management can improve your credit score and boost your creditworthiness. To harness the positive impact of borrowing, remember these tips:

✔️ Avoid High-Interest Personal Loans from Informal Lenders

Personal loans from informal lenders that advertise quick loan disbursement and no credit checks often carry exorbitant interest rates. As much as possible, don’t burden yourself with unmanageable repayments.

Plus, since they’re not legitimate loan providers, they won’t report your repayments to credit bureaus. Thus, these types of loans do nothing to help improve your credit score. 

Read more: 

• Need a Financial Boost? Check Out These 19 Low-Interest Personal Loans
• How to Compute Loan Interest and Monthly Amortization in the Philippines

✔️ Don’t Apply for Multiple Personal Loans

Shopping around and comparing personal loans to find the best rates and terms is acceptable. But it’s different when you simultaneously apply for all these loans. As mentioned, multiple loan applications result in multiple hard inquiries, negatively impacting your credit score. 

✔️ Never Miss a Loan Payment 

Payment delays or negligence can adversely affect your credit score. Before applying for one, ensure you can pay your monthly amortizations in full and on time every time. As long as you keep up with your payments, you should see improvements in your credit score. 

Related: 10 Best Personal Loans in the Philippines for Different Cash Needs

Final Thoughts 

Despite careful planning and budget management, you may still find yourself in situations where you’re short on cash. A personal loan is a quick and effective solution. And now that you know that a personal loan does affect your credit score, handle yours responsibly if you want to avail of credit under more favorable terms in the future. 

To get one that suits your needs and payment capacity, compare personal loans and apply via Moneymax. Click the banner to get started:

Sources: 

• ^[1] Hard Inquiry: Definition, How It Works, Impact on Credit Score (Investopedia, 2023)
• ^[2] Credit Utilization Ratio: Definition, Calculation, and How To Improve (Investopedia, 2023)