How Personal Loans Can Affect Your Credit Score
If you are careful with your credit standing, you might be wondering if taking out personal loans in Madison, TN could hurt your credit score. Well, there’s no straight answer here. In a way, there’s a negative impact on your credit score, but that’s not always the case because when you handle your finances right, they can also positively affect your score.
To know how to make this work for you, you need to understand how the FICO credit scoring works and then how applying for a personal loan could potentially affect it in a negative or positive way:
How the FICO Score Works
The FICO Score is what most lenders use, so this is what you need to focus on. There are five categories that make up your score:
Payment History – This makes up 35% of the score and has the heaviest impact on your score. Paying your bills on time each month affects your score in a positive way. Also, NOT paying on time can send your score plummeting because it’s that important.
Amount of Your Debt – Making up 30% of your score is the amount of debt you have. It’s not the actual amount in dollars that you owe per se that is referred here, but the balances relative to your limits or original loan balances.
Length of Credit History – More established debtors with a good record for longer years have higher scores than someone who also pays their debt but just for over a year. This factor makes up 15% of the total FICO score.
New Credit – Any recently opened account and even credit inquiries can hurt your credit score because they are perceived as a sign of financial trouble. New credits make up 10% of your total score.
Credit Mix – This has a higher significance if you have a short credit history and there’s not much information that lenders could use to assess your financial behavior. Lenders would want to be sure that you are responsible when it comes to different types of credit, be it an auto loan, credit card use, mortgage, and more. It takes up 10% of the total credit score.
Why Taking a Personal Loan Could Have Negative Impacts
Now that you better understand how FICO’s formula for credit scores work, you’ll get how taking a personal loan could have negative impacts on your score. You see, when you apply for a loan, the credit inquiry itself takes some points from your FICO score, and because the loan is a form of new credit, that means more points are taken.
Here’s a tip, though. There are lots of lenders that let you check your terms and rates for a personal loan without actually affecting your credit score. Mind that when you go beyond that pre-qualification stage, that’s already going to pull down your scores. The impact it makes lasts for a year. It shouldn’t be a big impact unless you’ve had more than a few new credit accounts in the same year.
Positive Impacts Could Be More Significant over Time
It’s true that you’ll immediately see the negative effects of getting a personal loan. That said, the long-term effects are more positive than negative. It’s because as you’re making your loan payments, you’re able to establish a more substantial payment history. You remember that it is the biggest contributing factor to FICO scoring.
Another positive effect is that as your loan balance steadily declines, you’ll get a better score in the category for amounts owed. Put that together with the payment history, and you’re raising 65% of your FICO score. That definitely outweighs the negative impact brought about by the “new credit.”
Taking a personal loan can have both positive and negative effects on your credit score. There’s no absolute way to predict how exactly the personal loan will hit your credit score. The most possible scenario is that when you take out personal installment loans in Madison, TN, you’ll get an immediate hit. But you’re going to see a positive shift in the coming months as you pay off your debt. And if you use that personal loan to pay off your credit cards, that positive effect can be seen even sooner.
When you’re ready to take that loan, First Finance Company is here to provide you with one that fits your needs exactly. Whether they’re small personal loans in Madison, TN, to more substantial ones, our team ensures fast service and a smooth application process. Contact us today to know more about our loans!