Deciding whether or not to get a personal loan is no easy decision. Chances are, if you’re contemplating getting one, you may not have a whole lot of other options. Personal loans can sometimes have a stigma or a bad rap.
If you’re wondering how does a personal loan affects your credit, know that they aren’t necessarily bad for your score. If you can afford to maintain the payments, a personal loan can be a lifeline when you need one most.
Here’s a round-up of everything you need to know about getting a personal loan and what they mean for your credit.
What Is a Personal Loan?
A personal loan is money that you borrow from a bank, online lender, or local credit union that you pay back in installments or fixed monthly payments. This loan is typically paid back over a short amount of time, between two and five years.
Your interest rates can vary widely on a personal loan, ranging from 6% to 36% APR. Your interest rate will always be affected in some way by your credit. If you don’t have the best credit, there are personal loans no credit check required that you may qualify for.
Since most personal loans aren’t backed by collateral such as your car or your home, they are considered unsecured. This makes a personal loan more expensive because there is more risk to your lender.
A personal loan is a loan you take out for any number of reasons. Maybe you want to consolidate your credit card debt or make some home improvements. In these situations, a personal loan can come in handy.
Reasons to Use Personal Loans
There are countless reasons someone might need a personal loan. A few common examples include:
- Consolidating credit card debt
- Paying off medical bills
- Making home improvements and can’t access a home equity loan
- You need to use a real estate bridge loan
- Making a large personal purchase
The Pros: Positives of Taking Out a Personal Loan
If you take out a personal loan and you have good financial habits, a personal loan can actually help your credit. Every time you make an installment payment on time that shows positively on your credit score.
If you make payments on your personal loan over a number of years, this can also boost your credit. Having a long credit history of positive payments is one of the best ways to keep your score up.
Another positive to take out a personal loan is when you’re using it to pay off other debt. Let’s say you take out a loan to pay off three credit cards. Now those credit cards no longer have a balance. That shows that you aren’t using all of your revolving credit.
Using your personal loan to make home improvements can also be positive. If you’re making improvements that increase your real estate value, you’ll see a good return on your investment, and you can often pay back your loan with the profits from your home.
The Cons: Are Personal Loans Bad?
Personal loans can definitely have some positives as well as negatives. With any loan, you’re adding more debt to your plate. With debt comes interest rates, more financial obligations, and less disposable income to save for an emergency, invest, or put away for retirement.
One negative to a personal loan is that they usually come with higher interest rates. This means you’ll pay more for your loan over time. If you’re able to take out a different type of loan or use savings or retirement income to finance what you need, it might make better financial sense.
Personal loans have higher interest rates because they are unsecured or not backed by collateral. Your mortgage, for example, is considered a secured loan because if you default the lender will take possession of your home. If you default on a personal loan, you can have a very severe impact on your credit score.
Keep in mind why you’re getting a personal loan in the first place. If you’re getting one because you can’t pay off your credit card debt, then you may not be able to pay back the personal loan either.
How Does a Personal Loan Affect Your Credit?
A personal loan can have both a positive and negative affect on your credit. If you fail to pay your personal loan on time or enter into default, you’ll see your credit score drop.
If you go into default, this can negatively impact your credit history for up to seven years. Going into collections will severely drop your score.
If you show a long history of paying your personal loan on time, your credit score will increase. Making timely installment loan payments is one of the biggest contributors to how high or low your credit score is.
How to Apply: Is It Hard to Get a Personal Loan?
Qualifying for a personal loan is much like any other loan. The main factors lenders look for when qualifying you for a personal loan are your income, your credit score, and your likeliness to stay on top of your payments.
A lender will want to see a good credit history and that you have the income and means to keep up with your payments. These factors show that you’re a reliable candidate for a loan.
You can always stay on top of your credit score with a free copy of your credit report, courtesy of the United States government. Knowing where you stand with your credit history can help you see how likely you are to get approved for a loan.
Personal Loans Are a Personal Choice
Whether or not you should get a personal loan is a very personal decision. In some cases, using cash or different types of loans may make more financial sense.
When deciding whether or not you should get a personal loan, you should first assess your ability to repay the loan. When you’re asking yourself, how does a personal loan affect your credit? Remember that the answer to that question is really up to you.
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