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Does Applying for a Loan Hurt Your Credit?

Credit scores can change frequently. At times, it may feel like it rises and lowers for no reason. But there is a method behind the madness of credit scores. And knowing the ins and outs of your credit score and credit report will save you many headaches in the future. If you’re one of the many Americans wondering, “does applying for a loan hurt your credit?” then you’ve come to the right place.

Tracking your credit score is a significant part of being financially stable. And knowing what it means to be financially stable is very important. If you know how it works, you can avoid the behaviors that lower it. And keeping your credit score in good shape will have many financial benefits for years to come. Read on to learn more about how your credit score works, what happens to it when you take out loans, and more.

What Exactly Is a Personal Loan?

A personal loan is one of the most common financial products on the market. However, there are a plethora of different types of personal loans. And they all have different amounts, interest rates, terms, and conditions. Being familiar with these everyday loan products can help you find the right one for you if you ever need one.

A personal loan is any loan product that a borrower uses to pay for personal expenses instead of business or commercial expenses.

As a borrower, you can use a personal loan to pay for whatever you need, assuming it’s legal, of course. Many borrowers use personal loans to pay for unexpected expenses or bills. For example, people use them for medical bills, vehicle repairs, children’s school costs, and other unexpected or unmanageable bills.

Personal Loans for Bad Credit

If you have poor credit, you may be wondering what types of personal loans are available to you. Luckily, there are several. But the key is to find a lender that caters to poor credit borrowers who are also credible and trustworthy.

Common poor credit loans include personal installment loans, title loans, payday loans, pawnshop loans, cash advance loans, and more.

Personal installment loans tend to be at the top of that list when it comes to credibility and trustworthiness. They offer borrowers larger amounts of cash than many others, with a longer and more flexible repayment period. If you need a personal loan, applying for an online installment loan for bad credit may be your best bet.

The other loans on that list tend to have a reputation for being a little bit…shady. For example, some payday and title lenders make their money by trapping borrowers into a cycle of debt.

There are some red flags you should be aware of when you’re searching for your personal loan:
  • Lack of transparency about the terms and conditions
  • Intentionally confusing terms and conditions
  • Extremely high interest rates
  • Extremely short or lump-sum repayment

Keep your eyes open for tactics like these. Avoid lenders that aren’t straightforward and won’t answer your questions or explain things clearly. If you do your homework and watch out for these warning signs, you can avoid predatory lenders.

Do Personal Loans Hurt Your Credit Score?

So now the all-important question: will your credit score drop if you take out a personal loan. And the short answer is…maybe.

We know that’s not the answer you probably want to hear. But credit scores can be complicated and precarious things. Several factors affect whether or not your credit score rises or falls.

The best way we can explain it is that having many different loans or credit cards is not great for your overall credit score. So if you take out a new loan, you may see your credit score drop. But if you continue to pay your loans and pay them off over time, your credit score will shoot back up.

So how exactly do these mysterious credit scores work? Let’s take a deeper dive, so you know what to expect when shopping around for a new personal loan or credit card.

How Your Credit Score Works

Your credit score is a three-digit number that represents your trustworthiness with money. This trustworthiness with money is sometimes called “creditworthiness.” If you’re creditworthy, it means you have a good credit history, and you manage your money well.

Three major companies track your credit history. They keep track of your financial behavior and compile it into things called “credit reports.”

These reports will show lenders, landlords, and even employers how you manage your money. Your credit report will include things like your payment history, student loans, your credit mix, and more. All your financial behavior will affect your credit score.

While each credit bureaus will have its own credit scoring models, the most common one that lenders check is your FICO score.

Here’s the breakdown of a FICO score:

0–580: Poor Credit

580–669: Fair Credit

670–739: Good Credit

740–799: Very Good Credit

800–850: Excellent Credit

Having a credit score of 670 and above will make it easier to borrow money and get reasonable interest rates. If you have a score below 670, you may still be able to get a loan, but you likely won’t receive excellent interest rates or flexible terms and conditions. Knowing what credit score is needed for a personal loan is crucial for your financial stability.

What’s Included In a Credit Report?

Now that you’re familiar with your credit score and what a good credit score is, let’s discuss how your score is created.

The three major credit bureaus monitor your financial behavior to create your credit reports. But what exactly is included in this report, and how do personal loans affect the overall report and score? Great questions!

Your credit report is created using the following breakdown of your financial behavior:

35% Payment History:

This is the most crucial aspect of your report. Your payment history makes up the most significant portion of your overall score. If you always make your personal loan payments on time, then you likely have a decent score. This is one way a personal loan affects your score. Therefore, always try to maintain a positive payment history.

30% Amounts Owed:

This is your total outstanding debt, including a personal loan, collections, or credit card debt. When it comes to debt, lower is better. Your score will rise if you pay down your overall debt. This factor also includes something called a credit utilization ratio. This ratio is how much credit you’re using compared to how much is available to you. Keep your credit utilization ratio under 30% to maintain good credit health.

15% Length of Credit History:

This is essentially how long you’ve been using credit and loan products. Of course, a longer history will bode well for your overall score. So if you don’t yet have any credit accounts and you’re considering a credit card or personal loan, it may be wise.

10% Credit Mix:

Your credit mix considers all of the different types of loans and credit that you’re currently using. If you have a diverse mix of financial products and manage them well, it will positively impact your credit score. On the other hand, if you take out a personal loan and already have many of the same types of loans on your report, it may lower your score.

10% New Credit

Opening a lot of new accounts in a short period tells lenders that you may be struggling financially. In addition, credit scores can drop if you open too many new accounts. This is the main way that a personal loan can affect your credit.

It’s essential to consider these factors when considering a new personal loan or any financial product. Now that you’re familiar with what kinds of things affect your credit, it’s easy to see how a personal loan can affect your credit score as well.

In Conclusion

Credit scores will rise and fall throughout the years. Sometimes you can’t help it. But understanding your credit score and how it’s created will help you to manage your score.

Keep an eye on your credit card balances, your credit utilization, how many accounts you have, and your overall debt. If you can keep these things in check, you have a good chance of improving your credit scores.

As you can see from the information above, a lot of different things affect your credit score. For example, taking out a personal loan might mean a drop in your credit scores, at least temporarily. But if you focus on paying off that personal loan on time, your credit scores will likely jump back up at some point.

Just remember to use your new understanding of credit scores before signing for that personal loan.

References:
What’s in my FICO Scores?
What is a FICO Score?