Do you want to apply for a personal loan but worried that will affect your credit? In short, the answer is it can hurt or improve your credit. Most of the time we’ve been given advice not to apply for new credit since it can affect our credit score. If you’re on the fence about applying for a personal loan, continue reading below to see how personal loans can have positive long-term effects on your credit score.
Can A Personal Loan Hurt Your Credit?
The way personal loans impact your credit will vary from person to person. And the reality is that personal loans can hurt your credit. Your financial behaviors will determine the how a personal loan will impact your credit score.
Initially, personal loans will hurt your credit since it will be considered as new credit on your credit report. With that said, you may be reluctant to apply for a personal loan. As we discuss how the FICO scoring model works, you’ll being to understand that it may not be as bad as you think. If you’re financially responsible, personal loans can have positive long-term effects.
FICO Score Scoring Model
The FICO Score is the most used scoring model by lenders today. Although there are many other score models, the FICO Score has been proven to be the most accurate. FICO Score is divided into five different categories each weighted differently.
1. Payment History:
Your payment history carries the most weight and has the biggest impact on your FICO score. This category is heavily weighted at 35%. Making monthly payments on time will mitigate any negative effects towards your score. But if you aren’t making monthly payments on time, your credit score will take a big hit since your payment history outweighs all other categories.
2. Amount Owed:
The amount of debt you owe to lenders is the second most weighted category towards your FICO score. This category is weighted 30% of your FICO score and should be monitored closely. If your credit report shows you owe a significant amount of debt, it may be perceived as financial struggle or signs of missed payments.
3. Credit History:
Your credit history is weighted 15% of your FICO score. In this case, having longer credit history is better. Lenders prefer borrowers who can show they’ve made monthly payments on time for 5 years showing less credit risk. If your credit report shows one year or less of credit history, lenders may consider you a credit risk since they don’t have enough historical data.
4. New Credit:
This category is weighted 10% of your FICO score. FICO will evaluate the number of credit accounts you’ve opened and amount of credit inquiries in the past year. If your credit report shows multiple credit card applications it can be perceived as financial struggle.
5. Credit Mix:
Your credit mix is weighted 10% of your FICO score. Credit mixed is scored based on your payment history on multiple types of credit accounts. All credit accounts will be considered which include your mortgage, credit cards, personal loans, etc. If your credit report shoes that you’ve struggle to maintain good standing with multiple accounts, lenders will view you as a credit risk.
Can A Personal Loan Hurt Your Credit?
Personal loans can benefit you in many ways and can help your credit. However, if you show financial struggle and irresponsible spending habits, personal loans can hurt your credit.
Here’s a few ways it can hurt your credit:
1. Applying For a Personal Loan:
Initially it can hurt your credit since it will be considered as “new credit.” In addition, applying for a personal loan will show as a hard credit check on your credit report.
2. Missed Payments:
Your payment history accounts for 35% of your FICO score. It’s important that you don’t miss any monthly payments since it will have a huge impact on your credit score.
How Can A Personal Loan Benefit Your Credit?
Applying for a personal loan can actually benefit your credit score. There are a few ways this can be done as long you can make the best financial decisions. At first glance, applying for a personal loan can be a bad idea since it’s considered as new credit. Luckily new credit is only 10% of your FICO score. So how can a personal loan benefit you? Looking at the bigger picture, a personal loan can have positive long-term effects on your credit score. If we look back at the FICO Score scoring model, a personal loan will have the most impact on your payment history and amount owed. The two categories combined account for 65% of your FICO score. To put it simply, just make your monthly payments on time. If you can do this one thing, you can show a positive payment history while reducing your total debt amount at the same time. The bottom line is that a personal loan can hurt your credit or improve your credit. Make sure you’re making the best financial decisions.