So you’re trying to rebuild your credit after a tough financial season. You’re considering applying for a loan to cover some unexpected expenses. But will applying for a loan damage your credit? Or can it help you build credit?
In this post, we’re going to look at three aspects of a personal loan and how they affect your credit. We’ll talk about how personal loans, credit checks, and early payoffs affect your credit.
1. Does a credit check hurt your credit score?
Ok, let’s talk about the credit check. Anytime you apply for a loan, the lender will check your credit. You’ve probably heard that a credit check hurts your credit. So let’s take a closer look at the real impact a credit check has on your credit score.
When it comes to checking your credit, there are two types of inquiries: “soft” and “hard.”
A soft inquiry occurs when you check your own credit score to work on keeping your credit healthy. This action is noted on your credit history but does not affect your score in any way. You can check your credit as often as you want with no impact on your score.
Another example of a soft credit check is when a lender checks your credit to pre-approve you for a loan or credit card. This check does not hurt your credit. However, when you decide to get the loan or credit card, the lender will have to run a hard credit check, which will impact your credit.
Hard credit checks are credit checks that lenders perform before approving you for a car loan, home loan, credit card, personal loan, and more. Hard credit checks do impact your credit score, but this isn’t necessarily as scary as it sounds.
Your credit score will temporarily drop an average of 5-10 points when a lender makes a hard inquiry. The score will rise again, usually within a couple of months. This small drop is usually not enough to seriously hurt your credit. However, what can damage your credit score is when you apply for multiple lines of credit in a short period of time. Multiple credit checks done in a short period signify to a creditor that you may be having financial challenges and lending to you could be risky.
So before you apply for a loan or credit card, do yourself a favor and check your credit history on your own first. This soft inquiry won’t impact your credit, but it will help you understand the health of your credit to know if you are likely to qualify for a loan or not. And do not apply for multiple loans, because this will seriously affect your credit score.
2. Should I pay off a personal loan early?
Paying off a personal installment loan generally doesn’t hurt your credit score. However, keeping it open for the full term of the loan can help you maintain your score. There are pros and cons to both.
If you pay off your loan early, you won’t be able to continue building your credit. On the other hand, an early payoff frees up space in your monthly budget, making your regular expenses more manageable.
The one question you’ll want to find out is this: does your loan company charge a penalty for early payoff? Many do. At Midwest Finance, our goal is to help you thrive financially in every way that we can. So we do not charge an early pay off fee.
3. Can accepting a personal installment loan improve your credit?
Personal loans will help you build or repair your credit score over time as long as you make regular, on-time payments. While your credit score may drop a little bit initially because of the hard credit check, after a few months, you will begin to see a steady rise in your score.
Getting a personal loan also expands your credit mix, which can help your credit score as well.
Your credit mix refers to the different types of credit lines you have on your report. Most people have one or more credit cards and a car loan. But expanding your credit mix with other types of credit can help.
So, in addition to credit cards and car loans, if you also have a home loan, student loan, and/or personal loan on your report, this expands your credit mix.
Pro Tip: Want to know how to boost your credit fast with a personal loan?
Most of the time, accepting a personal loan improves your credit score slowly and steadily. So if you’re looking for a fast way to improve your credit score, making consistent payments on one personal loan account probably isn’t going to accomplish what you hope it will.
However, there is one exception…
If you get a personal loan and use it to pay off a credit card, you can boost your credit score significantly in a short period. That’s because doing so affects one of the biggest factors that affect your credit: your “Credit Utilization Rate.”
Your Credit Utilization Rate is calculated by dividing the amount of credit you’re using by the amount of credit you have available. In other words, if you have two credit cards and one car loan which provide you with $10,000 total revolving credit at your disposal, a major factor determining in your credit score is what percentage of that $10,000 you are using.
If you are using $3,000 of your $10,000 available credit, then your Credit Utilization Rate is 30%, which is a very good rate. However, if you’re using $7,000 (or 70% of your available credit), it may look risky to lenders.
Using a personal loan to pay off a credit card can boost your credit score fast because you are increasing your total available credit while decreasing your Credit Utilization Rate.
So, let’s say you are using $7,000 (70%) of your $10,000 available credit, and then you get a $2,000 personal loan to pay off a portion of your debt. That means you’ve increased your available credit from $10,000 to $12,000, but you decrease your Credit Utilization Rate from 70% to 58%. You’ll see a nice (and fast) increase in your credit score through this method.
For more information about how personal loans affect your credit, contact Midwest Finance today.