Despite the risks, your personal loan account may end up helping you improve your credit. First, you add a positive payment history to your credit report, assuming you pay on time and on a regular basis. It can also increase your credit mix, especially if you previously had only credit cards and a personal loan is the first installment loan in your name. Credit scoring models reward borrowers who can competently monitor various types of credit.
Personal loans can help you build credit if you use them to consolidate debt or establish a history of on-time payments. If you decide to use a personal loan to create credit, remember to be aware of the risks involved and compare the quotes of several lenders to ensure you get the cheapest loan possible for your situation. Personal loans can be reported to credit reporting agencies. If yours is, it could be taken into account when calculating your credit ratings.
That means that a personal loan could hurt or help your credit scores. When you apply for a personal loan, you add the debt to the total amounts owed. This is likely to lower your credit rating in the short term. A higher debt burden is associated with a higher risk of taking on more than you can handle, meaning that lenders may consider you a higher risk.
Thorough research may cause your credit ratings to drop slightly, but they are likely to recover within a few months to a year and the impact will diminish over time as you continue to pay your bills on time and show other positive credit behavior. Finding the right loan can be particularly stressful when you're facing a financial emergency and need to borrow money in a hurry. For example, if you apply for a personal loan to pay off a credit card with the maximum limit, but then go on and reuse the credit card maximum immediately afterwards, you will have to pay more credit card debts and a personal loan. With regard to the length of your credit history, most traditional installment loans come with a repayment period of several years.
A debt consolidation loan allows you to borrow the money needed to pay off all three cards, and you'll repay that loan with one payment per month, often while saving money in the process due to lower interest rates. If you have credit card debt, an even greater benefit of consolidating your debt is being able to lower your credit utilization ratio. NerdWallet's personal loan marketplace allows you to compare multiple lenders with a single prequalification. Be sure to read the fine print to know what charges are associated with any loan before signing on the dotted line.
And if your credit report shows several requests for credit in a short period of time, lenders might think that your finances have changed negatively. For example, you can apply for a personal loan to start a new business, pay your medical bills, or finance an expensive but urgent repair of your home (such as a new roof in the middle of the rainy season). But remember that it's not just the loan itself, but the way you handle it that can make a difference. And a good mix of credit probably won't help your credit scores if you can't keep up with your payments.
This may help you, as financial institutions are more likely to see you as a more creditworthy borrower when you apply for a new form of credit, such as a mortgage or a car loan. Otherwise, you could be unfairly anchored some points in your credit rating if you perform a strict credit check instead. Some monitoring and alerts may not be available to you if the information you enter when you enroll does not match the information in your credit file with one or more consumer reporting agencies (or you do not have a file on). This debt cycle can also have a negative impact on your credit score if the burden of additional payments is so high that you start to lose monthly payments or do not make payments in full and it hurts your credit utilization ratio.