How Personal Loans Affect Your Credit Score (The Good and The Bad)

For better or worse, a consumer's credit score means everything to businesses. A high credit score gives a consumer more opportunities to borrow money. Lower scores may prevent someone from taking out a loan or even opening an account for utilities. By now, everyone knows how a credit score is used to determine loan approvals or denials. Most people may not know how a personal installment loan affects their score, though.
A Small Penalty In Applying For A Personal Loan
When someone applies for a loan, they give the lender permission to pull their credit report. This "hard pull" shows up on your credit report immediately. Unfortunately, a hard pull will drop an applicant's credit score by a few points on the spot. Lenders won't penalize an applicant for this slight drop since the application caused it. Future credit or loan applications will cause a similar effect to one's credit score.
Taking Out A Loan May Impact Credit As Well
After the loan is approved and disbursed, an individual might notice his or her credit score take a tip. Drops between 10 and 50 points are possible upon taking out a loan. Why does this happen? Well, creditors often view personal loans as a sign of financial hardship, at least at first. They're quick to assume an individual is strapped for cash and needs more in the form of credit, so they penalize the consumer temporarily.
The score drop should reverse itself after on-time payments start to hit the loan. Creditors will take notice of the payments and worry less about a given consumer. For many consumers, an initial score drop seems to disappear from a credit score within a few months. Banks and other financial institutions have to treat the situation like this in order to avoid losses by over-lending to consumers that have recently borrowed money.
Paying Down The Loan Brings Score Benefits
Consumers that pay off their installment loans will notice positive developments with their credit scores. As the loan is repaid, those on-time payments are reported to the credit bureaus more often than not. Payment history plays a key role in determining someone's credit score, and on-time payments mean good things to creditors. It's important to take every step necessary to ensure payments are made on time.
Otherwise, a poor payment history on installment accounts will tank a credit score. Even a single missed or late payment here and there can drop a score by 20 points. On-time payments won't offset a handful of late payments. For that reason, consumers need to pay their loans on time and avoid defaulting on even the smallest of balances. Negative payment history can drag an above average credit score down to the basement after all.
Don't Forget About Total Balances For Installment Accounts
An individual's credit score includes information on total balances for all installment accounts. If a given consumer has too much debt, then banks may hesitate to provide further credit to that consumer. To avoid this situation, each person needs to pay down their debts and maintain a reasonable amount of overall debt. It's perfectly fine to have multiple loans and credit cards, but the balances should be kept in check when possible.
Boosting A Credit Score The Right Way
Many consumers would like to boost their credit scores, even after they take out personal loans. Accomplishing this goal is no easy feat and requires some careful maneuvering. For starters, an individual should start paying down lines of credit immediately. Maintaining a low balance, or paying off a balance, will provide an immediate boost to the score. The same applies to catching up on late payments that might exist on a credit report.
Also, a consumer needs to check his or her credit score every month or two. Doing so ensures an individual knows what's on the report at all times. Inaccuracies and mistakes need to be disputed and corrected as soon as possible. A severe error on a credit report can drop someone's score by hundreds of points in egregious cases. For most consumers, diligence is the key to maintaining an excellent credit report and credit score.
The last thing someone should do is maintain a lax attitude toward their credit. Once a personal loan is approved, it's important to assess one's credit report. An installment loan will ding the score on a short-term basis. Proper management of the loan and other lines of credit will boost the score on a long-term basis, though. Either way, credit is a topic that most consumers don't understand completely. A little education and a willingness to improve can work wonders on someone's score within months.
Everyone should keep track of their credit score and know how a given personal loan or line of credit will impact their situation.