Considering a Personal Loan? Think About Your Credit First
(DailyDig.com) – Managing credit can be difficult. For people who want to have higher credit scores, taking on new debt such as personal loans may harm the overall score. Or, under the right circumstances, a personal loan can make a score higher. So, how can a personal loan help an overall score?
Does Taking Out a Personal Loan Hurt Your Credit Score?
Personal loans are sometimes unavoidable parts of life. A personal loan can make it easier to pay for dental procedures, help manage out-of-hand credit card bills, or pay for unexpected home repairs. As useful as personal loans are, it’s important to remember that these loans are another form of debt, and debt always has an effect on credit.
Pros
In some situations, a personal loan can have a positive effect on credit. For example, a score can be improved with a personal loan because the loan contributes to a better credit mix. The credit bureaus appreciate a variety of credit, so having a new type of credit can be beneficial. A personal loan is considered an unsecured loan. Having a good history with an unsecured loan on a credit report can make a borrower appear more trustworthy in the long run.
Credit cards, for example, are a revolving type of credit, while a personal loan is an installment type of credit. Because a personal loan will eventually be fully paid off, this can improve a score since an individual’s overall debt will go down over time. Using a personal loan to pay off credit cards can also lower the credit utilization ratio, or the measure of how much revolving credit is being used. Personal loans are not factored into this ratio.
Cons
On the other hand, there are some circumstances where a new personal loan can be detrimental to an overall score. For example, most people understand that a hard credit inquiry (which is generated when a person applies for any loan that involves a credit check) can hurt their score. A hard inquiry can have a lasting negative effect on credit ratings, sometimes as long one to two years. If a person is applying to multiple lenders, submitting loan applications all at once may minimize the long-term negative effect on their score.
Why Loans Make More Debt
In addition to a personal loan being another debt that needs to be repaid, these loans can also generate additional debt through interest rates and other fees. The way a personal loan is used may also create a negative effect. For example, taking out a personal loan to consolidate credit and then spending on credit cards again will do more harm than good in the long run.
Ultimately, your unique situation will determine whether or not a personal loan will help or hurt your credit score in the long run. Not sure what to do next? Talk to a credit repair specialist or financial adviser about your unique situation before filling in any applications. They’ll be able to help you assess your overall situation and goals to make the best choices.
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