At a Glance
There are three main credit bureaus that report credit scores: Equifax, Experian, and TransUnion. While each creates credit reports and scores based off different scoring models, lenders use the scores reported by these bureaus to determine whether you’ll be a responsible borrower and pay back loans on time.
That’s why your credit score is a key factor in applying for a loan, as it can impact whether you’re approved for the loan, loan terms you qualify for, and your interest rate. And with the total outstanding credit card debt in the U.S. reaching $890 billion in the second quarter of this year, a $100 billion increase from the same time last year, credit scores may be taking some major hits across the board, according to The New York Fed. In this article, learn more about:
- What is a personal loan?
- How do personal loans affect your credit score?
- Why your credit score is important when applying for a loan
- What credit score you need to get a personal loan
- What affects your credit score
- Factors that impact personal loan eligibility
- Personal loans for fair or bad credit
- How to improve your credit score
What is a personal loan?
A personal loan is a type of loan that you get from a bank, credit union, or online lender and repay in monthly installments. These funds can be used for just about anything, including moving expenses, medical bills, home renovations, car repairs, a wedding or vacation, emergency costs, and more.
Personal loans can be a great financing option for borrowers with good credit because they typically have fixed terms and fixed interest rates, making them easy to budget for and calculate repayment dates. Their loan amounts usually range from $1,000 to $100,000 with terms from 12 to 84 months.
How do personal loans affect your credit score?
When you first apply for a personal loan, it will trigger a hard credit inquiry. This inquiry will decrease your score by a few points for a short period of time, typically one or two months, though it will remain on your credit report for two years.
The other way your score can be negatively affected is if you make late payments or miss payments altogether. This can cause a significant drop in your credit score, and if you go several months without making a payment (typically two or three), you may be sent to a collection agency.
Otherwise, if you make your payments on time every month, your credit score may increase.
Read more: How to Improve Credit With a Personal Loan
Why your credit score is important when applying for a loan?
A credit score is a three-digit number that lenders use to assess the risk of lending money to a borrower. A high credit score indicates a low risk, while a low credit score indicates a high risk. For most personal loans, lenders will require a credit score of 660 or higher. However, some lenders may be willing to work with borrowers who have lower credit scores. In general, the higher the credit score, the lower the interest rate on the loan. For borrowers with excellent credit, it is possible to get a personal loan with an interest rate as low as 5%. Borrowers with poor credit may be charged an interest rate of 20% or more. In addition to credit score, lenders will also consider factors such as income, employment history, and debts when making a decision about whether to approve a loan.
What credit score do I need to get a personal loan?
There are different types of scoring models using and balancing data differently, and credit score ranges can vary based on the credit scoring model used. However, typically they align with:
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very good
- 800-850: Excellent
The general rule of thumb is the higher your credit score, the more likely you’ll be approved for a loan, and the better term and interest rate you’ll qualify for, but many lenders give preference to borrowers with scores of 670 and above.
The minimum credit score needed to get a personal loan can depend on the lender, but typically the minimum requirement is 610 and above. However, that doesn’t mean you can’t qualify for a loan if your score is lower than 610.
For example, the lender may require a FICO score of 640 or higher to get approved. Another lender may accept a 590, but will give much better terms and APR if the score is 740 or higher.
When you apply for a loan, it triggers a hard credit inquiry, which can decrease your score temporarily by a few points. So, before applying for loans, make sure to research or ask the lender if they have a minimum score requirement and what it is. If you don’t meet that score, don’t apply.
Most lenders also allow you to get prequalified for a loan, which gives you an estimate of your loan APR, term, and monthly payments based on your credit score and other factors. Doing this only triggers a soft credit check so your score is not affected, but it can give you a good idea of whether or not you’ll be approved and how much the loan will cost you.
What factors affect my credit score?
There are several factors that affect your credit score, including:
- Payment history: 35% of your score. Lenders want to make sure you have a history of making payments on time.
- Credit utilization: 30% of your score. Credit utilization is the total amount you owe on revolving credit lines, like credit cards, compared to your overall limits. It’s important to keep your credit utilization rate low because that shows lenders you’re not spending more than you should be.
- Length of credit history: 15% of your score. Typically, the longer your credit history, the more experienced you are with handling credit.
- New credit: 10% of your score. Because opening new accounts, like a credit card or loan, triggers a hard credit inquiry that impacts your score, opening multiple accounts in a short period of time can increase your risk to lenders.
- Credit mix: 10% of your score. Like investing, having a diverse portfolio of credit accounts can help show you are a responsible borrower and can manage multiple kinds of debt. These could be credit cards, student loans, auto loans, a mortgage, or other types of loans or financing.
Factors that impact personal loan eligibility
Your credit score is not the only factor that lenders consider when looking at your application. Other information they may look at includes:
- Credit history: Some lenders have a minimum requirement of two or three years of a credit history, but the longer your history, the better. Also having multiple accounts throughout your credit history, like different types of loans and credit cards, helps show the lender you’re a more responsible borrower.
- Debt-to-income ratio: Divide your monthly debt payments by your gross monthly income for your debt-to-income ratio, shown as a percentage. The lower your debt-to-income ratio, the better. Having a high debt-to-income ratio may signal to lenders that another loan may be difficult on your finances.
- Cash flow: Lenders may also look at bank transactions to better understand how much money borrowers have after paying other expenses, like groceries or rent. The greater your cash flow, the better.
- Income: You’ll likely need to show proof of income to support your ability to repay the loan. You may have to share pay stubs, proof of employment, tax returns, or documentation of other income sources.
- Collateral: In some cases, especially if you have a poor credit score, you may need to supply assets, like a car or house, as collateral to the loan. This can increase your chances of approval and qualifying for a lower interest rate, but the risk is you can lose the asset if you don’t pay back the loan.
Personal loans for fair or bad credit
Even if you have fair or poor credit, you can likely still find a lender who will approve your loan application. Most of the time, online lenders are more flexible with requirements compared to traditional banks or credit unions. Peer-to-peer lenders can also be an option.
Keep in mind that even if you’re approved, you’ll likely have higher interest rates and fees such as origination fees, early pay-off fees, and others. If you have poor credit, it’s important to do your research to compare lenders to find the best option for you.
Some examples of lenders who work with borrowers with fair or poor credit include:
- Avant (minimum 580)
- Upstart (minimum 300)
- OppLoans (no minimum)
- Peerform (minimum 600)
- BestEgg (minimum 640)
- LendingClub (minimum 600)
How to improve your credit score?
If your score needs some improvement to qualify for the best loan terms and interest rate, there are a few things you can do to increase it before applying for the loan.
- Carefully review your credit report to ensure there are no errors
- Pay your bills on time every month.
- Aim to pay off credit cards in full each month. If that’s not feasible, try to keep your credit utilization less than 30% of your available credit. The lower balance you carry, the better for your score.
- Don’t apply for credit cards or other loans because each one triggers a hard credit inquiry which lowers your score.
- Keep unused credit card accounts open because closing them can increase your credit utilization ratio, and the average age of your credit accounts decrease.
A loan application triggers a hard credit inquiry, which will temporarily decrease your credit score by a few points. Typically, it only affects your score for a short period of time, but the inquiry will remain on your credit report for two years.
In some cases, private loans aren’t reported to the credit bureaus, so they wouldn’t show up on your credit history or impact your credit score. However, other private loans, such as private student loans, do affect your score in the same way that a traditional personal loan would.
Related: How Student Loans Impact Your Life
While your score will temporarily decrease when you get approved for a personal loan, making your payments on time and in full each month can help improve your score.
While it seems counterintuitive, paying off debt can decrease your credit score for a short period of time, though this depends on several circumstances. Your credit score is made up of factors like payment history, credit utilization ratio, length of credit, credit mix, and new credit. So, if any of these are negatively affected, you may see a decrease in score.
There are seven steps to getting a personal loan. Start by checking your credit score, then compare estimated rates by using a personal loan calculator. You should also get prequalified for the loan where you can and use this information to shop around and compare lenders to find the best one for you. Once you do, you can apply for the loan, and if approved, accept the loan and get the funds.
Learn more: How to Get a Personal Loan in 7 Steps
How long it takes to get a personal loan depends on factors like where you got it, your credit score, income, application information, and others. In most cases, getting approved can take less than 24 hours with funding happening the next day, though it can take up to three to five business days to get approved and funded.
Learn more: How Long Does It Take to Get a Personal Loan