How Do Personal Loans Affect Your Credit Score?

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Over twenty million people living in the United States have an open personal loan. Personal loans are taken out for several reasons, and not all of them are bad. Buying a new car or house or consolidating debt are a few reasons why people take out personal loans. But even with good intentions, personal loans can affect your credit score.

What is a Credit Score?

Understanding what a credit score is can better help you understand how things affect it. A credit score is a system used to measure the creditworthiness of an individual. Credit scores are represented by numerical figures. These figures fluctuate depending on several factors. These factors include payment history, amounts owed, new credit lines, number of accounts, and the amount of credit available. These factors are not all weighted equally. Some factors have a bigger effect on your credit than others. For example, amounts owed count for 30% of your credit, while new credit lines only account for 10%.

What is a Personal Loan

A personal loan is a type of loan that can be used for nonspecific purposes. These loans differ from car, house, and student loans because they give borrowers the freedom to spend on what they need. These loans are offered by financial institutions such as banks, credit unions, and third-party lenders like Personal loans usually have an interest rate. This means that you will eventually pay back more than you borrowed. Interest rates vary by the institution you borrow from and your credit score. Banks and credit unions usually have lower interest rates than third-party or online lenders. Like many other types of loans, personal loans are paid back in installments. These installments are usually monthly but can also be weekly or bi-weekly.

Personal loans are commonly used for consolidating debt, medical and legal emergencies, and large purchases. However, they can also be used for miscellaneous purchases like weddings, vacations, or home improvement projects.

How Does Personal Loan Affect Your Credit Score?

Every aspect of the personal loan process affects your credit score. When first applying for a loan, lenders perform a credit check. This credit check is used to determine your eligibility for the loan. Credit checks can decrease a credit score but as much as ten points.

Personal loans are considered a debt and are calculated into the amount owed section of your credit. This portion of your credit score is worth 30%, meaning that debt will negatively impact your score. Consider your debt-to-income ratio when shopping for loans. Do not take out a loan amount that you are unable to pay back.

Paying your loan back will have the biggest impact on your score. If you pay your loan back on time and do not miss any payments, your credit score will increase. Likewise, if you do not pay your loan back on time and miss payments, you will see a decrease in your credit score. Missing too many payments can not only hurt your credit score but your payment history as well.

Personal loans will affect your credit score regardless of what you use them for. This is a major decision that should not be taken lightly. Taking out a personal loan can have lingering effects on your credit and can determine your future ability to make other purchases.

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