Getting a personal loan can either hurt or help your credit score, or both.
Getting a personal loan will affect your credit score but it’s not always in the way you think. In fact, the way a personal loan either helps to increase or hurt your credit score depends on where you’re at in the process.
Sound confusing? It is but understanding exactly how a peer-to-peer loan or another type of online loan affects your FICO can help save you thousands of dollars.
I’m going to reveal the three ways a personal loan will change your credit score, three different stages of the process that can hurt or help your score.
How to Shop Your Loan Around without Hurting Your Credit Score
Of the three ways a personal loan will hurt or help your FICO score, you’ll notice one is missing. Getting pre-approved for a loan actually has no effect on your score.
This is when you first click through to a peer-to-peer site or a lender and do that initial check on your credit. It takes less than a minute to fill out your contact information and the site comes back with an approval in less than five minutes.
The reason this doesn’t affect your credit score is because the lender does what’s called a ‘soft inquiry’ on your credit. This is similar to what happens when credit card companies pre-approve you for a new card. They do a quick check on your credit but it doesn’t stay on your report.
Since this pre-approval doesn’t stay on your credit report, there’s nothing to affect your credit score.
It’s an important step that most people don’t understand. It means you can (and should) shop your loan around to a few websites to make sure you get the best rate possible. You can get pre-approved on a couple of personal loan sites, it won’t affect your credit and you can fill out an application with whichever offers the best terms for your loan.
To get you started shopping around for the best rates, I’ve included a table with some of the personal loan and peer-to-peer lenders I’ve used.
|Peer to Peer Lending Site||Loan Fees||Credit Score Needed||Loan Rates||Notes|
|5%||580||9.95% to 36.0%||Best p2p loan site for bad credit borrowers. Lower credit score and three options including peer loans, bank loans and personal loans.|
|No Fee||Not available but higher than most, around 680 FICO||5.99% to 16.49% (fixed rate)|
5.74% to 14.6% (variable rate)
|Special discounts for variable rate loans. Offering $100 cash back on peer loans.|
|1% to 6%||620||6.25% to 30.0%||Best peer loans for graduates and no credit history.|
|No Fees||520||Vary by State||No fees and lowest credit requirements for lenders|
|1% to 6%||640||6.95% to 35.89%||Low rates on p2p loans for good credit borrowers.|
Applying for a Personal Loan and a Short-term Hit to Your Credit Score
Once you’ve found an online loan site with the best rate for your loan, you’ll need to fill out the complete application for a loan. This will include listing employment information, linking your bank account and providing any income verification if required. In all, it usually takes another five or ten minutes at the most.
This is the point where a personal loan WILL start affecting your credit score.
Your application for a loan goes on your credit report as a hard inquiry. It shows lenders how often you’ve been applying for loans and usually stays on your report for six months to a year. Hard inquiries will decrease your credit score but not by very much unless you start racking up lots of them.
Getting a hard inquiry or two on your credit report isn’t usually a big deal though. You’ve got the money you need from the loan and the inquiry will drop off your report within a year. When that happens, your credit score will bounce back up and it will be like it never happened.
How Getting a Personal Loan Affects Your FICO
That application and hard inquiry isn’t the only way a personal loan affects your credit score. Actually getting the loan will also tend to decrease your score in the short-term.
A personal loan goes on your credit report as non-revolving debt. This type of debt isn’t as bad as credit cards, which go on as revolving debt, but it still increases the total amount you owe. This is why it’s important to get as much as you need for your loan because it might be difficult to get another loan for about a year.
If you were to fill out another loan application, you’ll have to list your debt-to-income. This isn’t something that goes on your credit report but lenders like to look at it. That new loan you took out will increase your debt while your income stays the same, so it’s going to increase your debt-to-income ratio and will make it harder to get another loan whether your credit score is higher or not.
Paying off a Peer-to-Peer Loan Helps Your Credit Score
It’s not all bad news though when it comes to personal loans and your credit score. Making the regular monthly payments on your loan will build good credit history and lower your overall debt. Both of these will act to increase your credit score within a few months.
In fact, it’s not uncommon for a borrower to have a higher credit score within a year after getting a personal loan. This is especially true if you use it as a debt consolidation loan where you pay off some of the old credit card debt with the new loan. In this case, I’ve seen borrower’s credit score jump higher within a couple of months.
Even if you didn’t initially use your personal loan to pay off old debt, it’s a good idea to check your credit score once a year. If it’s much higher, it might be smart to apply for a new personal loan to pay off the old one and consolidate some bills. The lower rate you get because of your new, higher credit score can save you thousands on interest.
I built this easy loan payoff calculator to help see how much money you can save with a consolidation loan.
Be careful though, another way that personal loan can affect your credit is if you miss payments or stop paying altogether. A personal loan goes on your credit report just like any other debt. It might be an unsecured loan so you don’t have to worry about losing your home, but missing payments will still hurt your credit score and make any new loans much more expensive.
Loans and how they affect your credit can be confusing but it pays to understand what’s going on. Knowing how the loan process works can help you get the money you need and save thousands on interest. Debt is a tool. Just like a hammer, you can create something amazing if you know how to use it well.