How Does Applying for a Personal Loan Affect Your Credit Score?

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Does Applying for a Personal Loan Affect Credit Score?

Applying for a personal loan can be a viable solution when you need extra funds for various purposes, such as consolidating debt, funding a home improvement project, or covering unexpected expenses. However, before you decide to submit an application, it’s important to understand how it may impact your credit score.

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Understanding Credit Scores

First, let’s briefly discuss what a credit score is. A credit score is a three-digit number that represents your creditworthiness and is used by lenders to assess your ability to repay borrowed money. It is calculated based on various factors, such as your payment history, credit utilization, length of credit history, types of credit, and new credit applications.

The Impact of Loan Applications on Credit Scores

When you apply for a personal loan, the lender will typically conduct a hard inquiry on your credit report. This means that they will request a detailed report of your credit history from one or more credit bureaus. Hard inquiries can have a temporary negative impact on your credit score, usually resulting in a few points decrease.

However, the impact of a single hard inquiry is generally minimal and short-lived. According to credit scoring models, multiple loan applications within a short period are often treated as a single inquiry, as they indicate that you are shopping for the best loan terms rather than taking on excessive debt.

Rate Shopping and Credit Scores

Rate shopping is a common practice among borrowers who want to find the most favorable loan terms. When you’re rate shopping, you may submit loan applications to multiple lenders within a specific timeframe, usually around 14 to 45 days. The credit scoring models take this into account and consider multiple inquiries for the same type of loan as a single inquiry, minimizing the impact on your credit score.

It’s important to note that not all credit scoring models treat rate shopping the same way. For example, FICO® Scores group multiple inquiries for the same type of loan made within a 45-day period as a single inquiry, while VantageScore® considers a 14-day window.

Monitoring Your Credit Score

While applying for a personal loan may have a temporary impact on your credit score, it is crucial to monitor your credit regularly. By keeping an eye on your credit report, you can ensure its accuracy and identify any potential errors or fraudulent activity.

Fortunately, you are entitled to a free copy of your credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) once a year. You can request these reports through AnnualCreditReport.com, the only authorized website for free credit reports.

Additionally, many financial institutions and credit card companies now offer free credit score monitoring services. These services allow you to track changes in your credit score over time, receive alerts for significant changes, and gain insights into the factors affecting your score.

Conclusion

Applying for a personal loan may have a temporary and minor impact on your credit score due to the hard inquiry conducted by the lender. However, if you are rate shopping within a specific timeframe, the credit scoring models will typically consider multiple inquiries as a single inquiry, minimizing the impact on your score.

Remember to monitor your credit regularly to ensure its accuracy and address any issues promptly. By understanding how loan applications affect your credit score, you can make informed decisions and maintain a healthy credit profile.

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