How does a personal loan affect your credit score?
A personal loan can improve your credit score in the long term as long as you consistently repay the debt on time.
There’s no mystery to it: A personal loan affects your credit score much like any other form of credit. Make on-time payments and build your credit. Any late payments can significantly damage your score if they’re reported to the credit reference agencies.
A personal loan can affect your credit score when:
- You shop for a personal loan.
- You apply for a personal loan.
- You regularly repay your personal loan.
- You miss a personal loan repayment.
- You consolidate your debt.
Shopping for a personal loan
Most online lenders allow you to see your 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.
Some lenders, including many banks and credit unions, do not offer a soft check so if you’re just comparing rates, opt for lenders that do.
» COMPARE: 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.
» MORE: How to apply for a personal loan
Repaying your personal loan
A number of factors affect your credit score, but making payments on time will show you to be a responsible borrower and will help improve your score. Developing a record of consistent, on-time payments toward your debt helps build credit history in the long term.
Most online lenders report repayment activity to one or all three national credit reference agencies — Equifax, Experian and TransUnion. Working with a lender that reports to all three can mean more consistency across your credit reports.
Missing a loan repayment
A missed loan repayment can be reported to credit reference agencies and affect 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.
Consolidating your debt
Consolidating debts into a personal loan can improve your credit by lowering your credit utilisation. Your credit utilisation ratio — how much of your available credit you use — can affect your credit score, as not using all your available credit can indicate that you manage your money responsibly. This positive effect is based on the assumption that you keep up with repayments, and do not take on more borrowing following your debt consolidation.
Personal loans also help improve your credit mix. It adds instalment credit to your report, a different form of credit than the revolving credit associated with credit cards.
Image source: Getty Images
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.
Rhiannon is a financial writer for NerdWallet, with a particular interest in personal finance and insurance guides for consumers. Read more