How Does a Personal Loan Impact Your Credit?

When it comes to taking charge of your finances, a personal loan can be a good option. You can use personal loans to consolidate debt, get a better interest rate than credit card debt, or cover emergency expenses. "A personal loan is a budget-friendly payment alternative that gives consumers the option to pay over time for large purchases rather than upfront in one large payment," explains Hans Zandhuis, head of Ally Lending. "In addition, a personal loan gives consumers more control over how and when they want to make payments, which typically is not available with other types of loans like mortgages."

So, how does a personal loan impact your credit? We asked Zandhuis and here's what he had to say.

Factoring Credit Scores

Credit allows people to buy something now and pay for it later, or over a period of time. The three main credit bureaus—Experian, Equifax, and TransUnion—keep a track record of our credit amounts, limits, and payment histories. An algorithm calculates the credit score that lenders use to determine their risk in extending credit to someone. Will this person pay back the loan? Can they afford the payments? While the system is not perfect and ignores things out of our control, like periods of unemployment or financial downturns that can make it difficult for even the most conscientious person to pay back their loans, it does serve as a good indicator of whether a creditor should extend credit to someone.

Higher credit scores tend to get better interest rates and credit approvals, while lower scores can be denied new credit altogether. "Most lenders require their borrowers to have a good credit score, which generally is considered to be 670 or higher," Zandhuis says. "There are easy, free services, such as Credit Karma and Experian, where consumers can check their credit score." A better credit score can make it easier to get approved for a personal loan.

How to Apply for a Personal Loan

Because a personal loan is an extension of credit, the lenders will look up your credit score and report to the credit bureaus whether you are making your payments on time, late, or not at all. If you had a decent credit score and consolidated your debt with a personal loan, then making on time payments can help to boost your score. Missing payments or being consistently late will ding your score a few points until you catch up.

"At Ally Lending, consumers can pre-qualify for a personal loan with no credit impact and review an array of options before committing. A hard credit check occurs after the consumer selects a loan and wants to move forward with signing and finalizing the loan," says Zandhuis. "However, it's important for consumers to make on-time payments throughout their loan term in order to keep your credit score in good standing. An Ally Lending personal loan helps consumers manage larger expenses—ranging from $500 to $40,000—without needing to take out a line of credit, max out credit cards, or drain savings. The benefit of this type of pay-over-time financing is flexibility combined with affordability."

Personal loans can provide many financial benefits depending on your situation. Even so, you need to consider the full cost of the loan (base loan amount plus the interest and any fees) and your ability to make the monthly payments before you take on a loan. Your credit score will also factor into your eligibility to get approved for a loan. But if you have a good score and keep up with your payments, the impact on your credit score could be the boost you need to get approved for other types of loans, like mortgages or car loans.