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There is no getting away from it: taking out a personal loan could affect your credit score, much like any other form of credit. For instance, make repayments on time and you could build up your credit history. On the other hand, if your repayments are late, it could damage your score.
Overall, a personal loan could potentially affect your credit score when you:
- shop for a personal loan.
- apply for a personal loan.
- regularly repay your personal loan.
- miss a personal loan repayment.
- consolidate your debt.
Shopping for a personal loan
Most lenders allow potential borrowers to check their eligibility for a personal loan with a soft credit check, which is a routine check of your creditworthiness. A soft inquiry won’t affect your credit score, and it allows you to shop around for the best rates and terms. By checking if you’re eligible for a loan, you reduce the chances of applying for an unsuitable loan, having your application rejected, and leaving a mark on your credit history.
Some lenders may not offer a soft check so if you’re just comparing rates, it may be best to opt for lenders that do.
» COMPARE: Best personal loans
Applying for a personal loan
Formally applying for a personal loan triggers a hard credit check, which is a more thorough evaluation of your credit history.
A hard inquiry typically stays on your credit report for 12 months, although certain checks may stay for longer.
If you apply for a loan or any other form of credit multiple times in a short period, your credit score could be adversely affected. As a result, it makes sense to only apply for a loan if you are confident that you will be accepted, by checking your eligibility first, for example.
» MORE: What credit score do I need for loan?
Repaying your personal loan
Once you have a loan, making payments on time will show you to be a responsible borrower and could help improve your credit score. However, make sure you’re managing any other credit responsibilities effectively too, not just one particular loan, if you want to see your score improve. Developing a record of consistent, on-time repayments of your loan can help build credit history in the long term.
Lenders can report repayment activity to one or more of the three main credit reference agencies in the UK – Equifax, Experian and TransUnion.
Missing a loan repayment
A late or missed loan repayment can be reported to credit reference agencies and could have a negative impact on your credit score.
Lenders may set different time limits to determine when a payment is late and may charge late payment fees, so it is worth checking the terms of your agreement to see exactly what impact missing a payment could have.
Establishing a budget that accounts for all your debt repayments, including your personal loan, can help you avoid missed payments.
» MORE: What happens if you can’t make a payment?
Consolidating your debt
Consolidating debts into a personal loan may help improve your credit score, as it can make it easier to keep track of your debts and make payments on time. This positive effect is based on the assumption that you keep up with all your other repayments too, and don’t take on more debt.
However, applying for a loan to consolidate your debt would require a hard credit check and could temporarily affect your credit score.
Debt consolidation could also affect your credit utilisation. Your credit utilisation ratio – how much of your available credit you use – can affect your credit score, as it can indicate how well you are managing your finances.
If you consolidate debts, you may end up closing some accounts, such as an unused credit card. This may mean you have a lower overall credit limit, which would then mean you’re using more of your available credit. This could affect your credit score but, as long as you make all your repayments on time, this impact should be temporary.
» MORE: Debt consolidation loans
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This article was originally written by Narottam Medhora, a former personal loans and small business writer for NerdWallet and subsequently updated by the NerdWallet UK Editorial team.
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