How Do Personal Loans Raise Credit Scores? Plus Downsides

If you need funds to consolidate high-interest debt, make a big-ticket purchase, or need cash fast, a personal loan is what you’re looking for. However, consider that taking out any loan will impact your credit score, depending on how you handle the loan payments after approval.

It isn’t easy to forecast the impact, though. This is due to the several credit scoring models available from firms such as FICO® and VantageScore®. Furthermore, it also relies on your financial situation. In general, a personal loan may either improve or damage your credit score. Continue reading to learn how.

How Exactly Does a Personal Loan Improve Your Score?     

Personal loans can help you boost your credit score in various ways, depending on how you utilize the cash and fulfill your payments.

1. Contributing to a better credit mix

Having various types of credit can boost your credit score. A personal loan is a loan that is paid back in installments (meaning you pay it off in regular monthly installments). An installment type like a personal loan can improve your credit mix, especially if most of your credit is revolving credit, such as credit cards. Read our article on the difference between revolving and installment loans to learn more!

2. Lower credit utilization

The amount you owe – or, more precisely, the amount you owe relative to your credit limits or the initial amounts of your loans – is one of the essential components of your credit score. The “credit usage” category accounts for 30% of your FICO credit score.

As a result, if you take out a personal loan to consolidate all of your credit card obligations, your credit card credit utilization essentially decreases to zero. As long as you keep your credit card accounts active (and your balances low), this will likely have a positive effect on your credit score.

3. If You Make On-Time Payments

Making on-time payments every month may help you build an excellent payment history. According to the Consumer Financial Protection Bureau (CFPB), a strong payment history may help you improve or maintain your credit score.

If you need assistance with bill payments, you can create a budget, set up automated payments or reminder notifications.

The Drawbacks of Taking Out a Personal Loan

Are you prepared to fill out that personal loan application? Not so fast. Personal loans do have certain drawbacks you should be aware of.

1. Inviting a Hard Inquiry on Your Credit Report

When you apply for any form of credit, including a personal loan, lenders will run a credit check on you. This may result in a hard inquiry on your credit report, which negatively impacts your credit score. The drop from a single hard inquiry lasts just a few months; however, too many hard inquiries might cause more significant damage to your credit score.

2. Taking on More Debt

Any loan that you take out is a debt that you incur. It’s important to remember that you shouldn’t take out a loan if the debt would put you in deeper financial trouble.

Even if you’re utilizing your personal loan to pay off debt and decrease interest rates, you must take measures to restrict extravagant spending habits that might generate extra debt while you’re paying off your personal loan.

3. Other Fees

There is more to pay on a personal loan than just the borrowed money and interest. Almost every loan product has costs attached to it. While these costs are modest compared to the loan itself, you must consider them before applying.

Conclusion

As previously said, the most crucial aspect of obtaining a personal loan is to use it wisely. Don’t borrow more money than you need, make your payments on time, and ensure your payment amounts are within your budget. You might even utilize your personal loan to consolidate high-interest credit card debt.

If you do all of that, your personal loan may end up having a net positive effect on your credit score.

If you’re looking for a reliable company that offers personal loans in Huntsville, AL, Magnolia Finance Company can help! We provide various personal loan sizes to fit our customer’s needs. No matter your credit score, we go the extra mile to put something on the table you can afford. Get in touch with us today!