How does a personal loan affect your credit?

When faced with large expenses like home renovations or repairs, personal loans offer a convenient way to quickly access a lump sum. If you’re thinking about a personal loan, keep in mind that, like credit cards and mortgages, personal loans can affect your credit. Let’s look at how applying for and repaying a personal loan can impact your credit.

How a personal loan can help your credit

Using a personal loan responsibly can improve your credit in several ways, including through on-time payments and debt consolidation.

Repayment history

Your payment history factors heavily into your credit score. It shows whether you’ve consistently made on-time payments and how often you’ve missed payments. Making your monthly loan payments in full and on time helps you build a positive payment history, which can boost your credit score.

Credit mix

The types of credit you have also impact your credit score – this is called your credit mix, and it refers to the different types of accounts you have, such as mortgages and credit cards. If, for example, you’re only using credit cards, a personal loan can diversify your credit mix and improve your credit score.

Credit utilization

Your credit utilization ratio reflects how much of your available revolving credit you're currently using. While personal loans don't impact this ratio directly, securing a personal loan to consolidate credit card debt can effectively lower your credit utilization ratio and improve your credit score. This is because consolidating debt with a personal loan replaces your revolving debt (which counts toward your credit utilization) with an installment loan (which doesn’t count toward your credit utilization).

How a personal loan can hurt your credit

Personal loans can hurt your credit score if you don’t use them responsibly. They can also lower the average age of your accounts and trigger a hard credit inquiry.

Hard credit inquiries

Every time you apply for a personal loan, the lender performs a hard credit inquiry that can temporarily lower your credit score by several points. Submitting multiple personal loan applications at the same time can significantly impact your credit score. Instead of applying for multiple loans, try to narrow down potential lenders by comparing rates and terms before submitting an application.

Late payments

While timely payments can help improve your score by building a positive repayment history, loan payments made after the due date can damage your score. 

Some lenders may not report payments that are just a few days late to credit bureaus – if you’re able to make the full payment within 30 days, lenders and creditors might not report it as late. However, there may still be a late fee. If you’re only able to make a partial payment, the lender will typically report it as late.

Age of credit accounts

Getting a new loan or opening a new credit card brings down the average age of your accounts, which can lower your credit score slightly.

Should you take out a personal loan to boost your credit?

While personal loans can help boost your credit, it typically makes sense to apply for a personal loan only if you need it. For example, using a personal loan to consolidate debt and get a better interest rate can work to your advantage, while also diversifying your credit mix and lowering your credit utilization. But getting a personal loan solely to build credit may mean you’ll lose money to interest and fees.

There’s something called a credit-builder loan designed to help borrowers improve their credit – these allow you to take out a small debt and repay it over time to show that you’re a responsible borrower.

How to use a personal loan responsibly

Here are some ways to get the most out of your personal loan:

• Research the right loan amount for your income range
• Compare rates where possible to find the best option
• Ask lenders about grace periods and late fees
• Don’t agree to a monthly payment that you may not be able to make. Instead, discuss extending the loan term in favor of a lower monthly payment, but realize you will be paying more interest with the longer-term loan.
• Focus on making timely payments. Set up reminders or automatic payments if possible.

Citi offers personal loans to both existing Citi customers and new Citi customers that meet specific eligibility criteria, including an established credit and income history along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.

Disclosure: This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.