How a Personal Loan Affects Your Credit Score
Personal loans serve a variety of purposes, from debt consolidation to home renovation. But some people are concerned about the effect on their credit score when they take out a personal loan. Do personal loans lower your credit score?
According to a new study from LendingTree, 62% of borrowers actually experience an increase in their credit score within the first month of taking out a personal loan. That seems great at first glance, but the increase does not last forever.
After 12 months, 45% of borrowers still have higher credit scores than when they took out the loan. On average though, borrowers see a 10 point decrease in their credit score one year after getting a personal loan. People with credit scores of 700 to 749 see the biggest drop, losing an average of 25 credit points. By comparison, people with scores less than 620 still see a 10-point increase after 12 months.
What causes this spike, followed by decline? It may stem from the reason people get a loan in the first place. A previous study showed 39% of Americans use personal loans to consolidate debt, and 22% use it to pay off credit card debt. Thus, the initial increase in scores could be from paying down on the old debts. The eventual decline could be the result of the same financial habits that caused the need for the loan–i.e. late payments or new credit card debt.
It is also important to note that not everyone takes out a loan to pay off existing debts. Adding new debt will inevitably cause a drop in credit scores until there is enough positive repayment history to offset the debt.