Personal loans affect your credit score in the short-term and in the long-term. In the short-term, a personal loan may damage your score because it causes a hard credit inquiry and increases your debt load. But in the long-term, a personal loan can either help or hurt your credit, depending largely on whether or not you pay the bills on time. Ultimately, it’s up to you how much impact the personal loan will have.
How a Personal Loan Affects Your Credit Score:
Does temporary damage with an initial hard inquiry. When you first apply for a personal loan, your credit score will immediately take a small hit. That’s because applying for a personal loan triggers a hard inquiry into your credit history. But this shouldn’t drop your score by more than 5 points or so, and you should be able to bounce back quickly.
Adds to your overall debt. If you’re approved for a personal loan, you will immediately have a higher debt load, which may cause your credit score to drop in the short-term. That’s because the more debt you have, the riskier it is for banks and credit unions to lend to you.
Reports to the major credit bureaus monthly. The banks, credit unions and online lenders that issue personal loans report payment information to the major credit bureaus on a monthly basis. If you make on-time payments, you can expect your score to increase. But if you are late or don’t pay altogether, your score will drop.
Improves your credit mix. Proving yourself capable of managing multiple types of loans and lines of credit responsibly is good for your credit score. It shows you can be trusted to repay what you borrow in a variety of situations. So if you only have one or two other types of accounts on your credit report, such as credit cards or student loans, your score may benefit in the long run from getting the personal loan.
Could help reduce credit utilization. Personal loans give you a lump sum up front, which you pay back in monthly installments. This is different from a credit card, where you can borrow up to a certain amount any time you want. Credit cards are known as “revolving credit,” and a big part of your credit score is how much of your revolving credit you use up each month, or your “credit utilization ratio.” Personal loans don’t count toward this ratio, so if you use them to pay off revolving debt, you can lower your ratio and improve your score.
In conclusion, as long as you’re sure to pay on time each month, a personal loan should eventually increase your score by a lot more than the initial inquiry caused it to fall. You can also avoid wasting hard inquiries by getting pre-qualified for a loan first. Pre-qualification only uses a harmless soft inquiry. And while it doesn’t guarantee approval, it will let you know if your odds are good.
You should get a personal loan if you really need to borrow the money and the loan has better terms than other borrowing methods available to you. For example, in certain situations, a credit card or home equity loan might be a better choice. In addition, you should only get a personal loan if you are confident that you can pay the loan off on schedule. Borrowers have defaulted on 3% - 4% of personal loans since 2016, down from 4.8% a decade prior, according to TransUnion. Defaulting on a loan results in significant credit-score damage.… read full answer
If you’re on the fence about whether you should get a personal loan, you can follow this simple checklist. You’ll need to check off all the items for a loan to be worthwhile.
When you should get a personal loan:
The expense is necessary. You can get a personal loan for almost any purpose. But it’s wiser to use a loan for important things like consolidating debt or making home improvements that will increase the value of your property.
Credit cards aren’t a better option. People with good or excellent credit will likely find better long-term interest rates on personal loans than on credit cards. But there are plenty of credit cards with introductory 0% rates for 12-18 months on purchases. So 0% APR credit cards may be the better choice for smaller expenses.
Home equity loans/lines of credit aren’t a better option. You can probably expect to get lower interest rates on a home equity loan or home equity line of credit than with a personal loan, and you may be able to borrow more than you could with a personal loan. But home equity loans and HELOCs use your house as collateral, whereas most personal loans require no collateral. Think over your options in detail before choosing.
You’re confident you can pay it off. Personal loans can last anywhere from 12 to 84 months, though 60 months is a more typical cap. You’ll make payments in equal monthly installments. Before agreeing to a personal loan, look at the monthly payment and put it in the context of all your other monthly expenses. You should be able to comfortably afford the loan payment, and not have to worry about being late.
You can qualify. To get an unsecured personal loan (a loan that doesn’t require collateral) you’ll need a credit score of at least 585. And you probably won’t be able to get a loan without an origination fee unless your score is at least 660.
There are many situations when you should get a personal loan instead of borrowing another way. But there are also plenty of cases where you should not get a personal loan or even borrow at all. For example, taking out a personal loan to go on vacation or to throw a wedding isn’t ideal. It’ll take months or years to pay off the debt from something that only lasted a day or week. In addition, you’ll want to avoid personal loans when you can get a better deal through other borrowing methods.
There are several other cases when you should not use a personal loan either. For example, it’s not a good idea to borrow money to make investments you’re not confident will pay off in the future. And your chances of getting an unsecured personal loan aren’t great when your credit score is below 585. Personal loans are also not ideal in emergencies when you need immediate cash, because the lenders usually take at least a few business days to approve you and deliver the money. You might consider using a credit card or borrowing from family in an emergency instead.
Bottom line: Make sure to compare all options thoroughly before you commit to one.
The most common reasons for taking out a personal loan include medical bills, home improvements and debt consolidation. But the list of possible reasons why someone might want to apply for a personal loan is nearly infinite, as the funds from personal loans can be used for almost any purpose. Very few restrictions exist. Illegal activities and gambling are not valid loan uses, and you typically will not be able to use a personal loan for college education (you’ll use a student loan instead). But that’s about it.… read full answer
However, legitimately good reasons to get a personal loan only represent a small fraction of the countless motivations people have for wanting to borrow. The best reasons to get a personal loan are to pay off unavoidable, urgent expenses (e.g. hospital bills) and to make investments that will pay off in the future (e.g. home improvements that increase your house’s value).
You can use personal loans to pay for less urgent things, such as weddings or vacations, too. But it’s best not to go into debt for those kinds of expenses. The more responsible course of action is to pay with money you already have, so that if a financial emergency hits, you won’t already be in debt.
Reasons to Get Personal Loans:
They are versatile: The most common reasons for applying for personal loans include medical emergencies, debt consolidation, major purchases and home improvements.
They can have lower APRs than credit cards. New credit card offers have an average regular APR around 19%. The average personal loan APR is closer to 10%, and personal loans can have APRs as low as around 4%.
They offer flexible funding. Most personal loan providers offer minimum loan amounts of $1,000 to $5,000. But their maximum loan amounts can stretch anywhere from $25,000 to $100,000.
They have decent payoff periods. Personal loans can give you anywhere from 1 to 12 years to pay off the balance. While that’s shorter than the terms offered by some types of financing, like home equity loans, it’s a lot longer than the 0% introductory periods offered on credit cards (6 to 21 months).
They’re fast. Most personal loan providers will approve and fund you in less than a week. And the very best options can provide funding as soon as the same day you apply.
They usually don’t require collateral. The majority of personal loans are unsecured, although secured personal loans do exist.
There are lots of options. Tons of lenders offer personal loans, from banks to credit unions to online companies. There are choices for people of all credit levels.
There are a lot of good reasons to get a personal loan, and a multitude of different situations in which you can use one. If you’re ready to start your search, you can compare personal loans on WalletHub and get pre-qualified with multiple lenders without hurting your credit score.
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