If you need to apply for a personal loan, your credit score can have a big impact on how much you'll pay in interest and fees over the lifetime of the loan. With a lower credit score, you could end up paying thousands of dollars more in interest. Do you have a good credit score compared to other borrowers? Read on to understand the average credit score for personal loans and the factors that influence the rates you might see.
What Is A Personal Loan?
A personal loan is any loan given to an individual for discretionary use. You could get a personal loan for unexpected medical expenses, home renovations, a business expansion, or to consolidate debt. Some people will also take a personal loan to finance a major purchase with a TV, car, or vacation.
A personal loan can be secured or unsecured, fixed-rate, or variable-rate. You can get personal loans from banks, credit unions, online lenders, or peer-to-peer lenders.
Impact Of Personal Loans On Your Credit Score
Personal loans can influence your credit score positively or negatively, depending on how you use them. Taking a personal loan may cause a temporary dip in your credit score. As you make on-time payments to repay the loan, the personal loan could positively affect your credit score. Making timely payments is essential to maintain or improve your credit score, as a single missed payment will stay on your credit score for seven years.
Positive Effects Of Personal Loans On Your Credit Score
Taking a personal loan can diversify your credit mix and demonstrate your creditworthiness as long as you consistently pay on time. For this reason, responsible borrowing and timely repayment of personal loans can contribute to a positive credit history. With on-time payments, personal loans' effect on credit scores can be positive long-term.
Potential Negative Effects On Your Credit Score
Opening a new credit account (like a personal loan) can temporarily lower your credit score. However, this dip should be temporary. On the other hand, missed payments or defaulting on a loan can significantly negatively impact your credit history. Late payments will impact your credit score for seven years. When you take a personal loan, you risk these negative effects if you can't pay on time.
Minimum Credit Score Requirement For Personal Loans
The importance of credit scores in the personal loan application process cannot be over-emphasized. Different lenders may have varying credit score requirements for granting personal loans, so your credit score loan qualification can vary.
While you can get a personal loan with a loan credit score, interest rates could be as high as credit cards or higher. Here's what you need to know about credit scores for personal loans:
Understanding Credit Score Requirements For Personal Loans
Typical credit score ranges that lenders may look for when considering personal loan applications vary, although a credit score of around 600 or higher is often the minimum for approval by many lenders. However, some lenders specialize in personal loans for borrowers with low credit scores.
Factors That Influence Credit Score Requirements
Beyond credit score, factors that lenders might consider include income, debt-to-income ratio, savings, and employment history. Some lenders may be more flexible in their requirements if applicants have a strong financial profile, such as a strong employment history, high income, or significant savings.
Tips For Qualifying With Lower Credit Scores
To improve credit scores before applying for a personal loan, be sure to pay bills on time to build or maintain a positive payment history. If you can, work to reduce outstanding debts and correct any errors on your credit report.
You're entitled to one free credit report annually. Be sure to check it for any mistakes and request corrections. You can get a copy of your credit report from all three credit bureaus at annualcreditreport.com.
To boost your credit score quickly, consider asking a friend or family member to add you as an authorized user on their credit card if they have a high credit score. Likewise, you can consider a rent reporting company to report on-time rent and utilities payments.
If your score is below the typical threshold, you can also work with a lender specializing in loans for borrowers with lower credit scores.
Comparing Different Personal Loan Options
Understanding the nuances of different loans can help you select the best fit for your financial needs. Carefully evaluate various personal loan options before making a decision. Compare loan types, lenders' terms, and total fees before selecting a personal loan for your credit score.
Types Of Personal Loans
Common types of personal loans include secured and unsecured loans, fixed-rate and variable-rate loans, and debt consolidation loans. Unsecured loans don't require collateral, while secured loans require collateral like a house, car, or other asset.
Fixed-rate loans maintain the same interest rate throughout the loan term, while variable-rate loans are linked to an underlying benchmark interest rate or index and change periodically with the market.
For borrowers with high credit scores, either secured or unsecured loans are good options. For borrowers with low credit scores, secured loans can offer lower interest rates. If you need to pay less in interest in the first year, a variable-rate loan may be better; otherwise, fixed-rate loans offer greater stability.
Debt consolidation loans are specifically aimed at borrowers who want to combine multiple debts, like credit card debt, into a single, lower-interest payment.
Interest Rates And Terms
Interest rates vary based on loan type, credit score, and market conditions. Keep in mind that interest rates and loan terms can greatly impact determining the total cost of the loan.
For example, on a $10,000, five-year personal loan with a 7% interest rate, you'll pay $1,880.72 in interest. If the interest rate is 11%, which is still considered a good personal loan interest rate, you'll pay $3,045.45 in interest. If the interest rate is 15%, interest payments jump to $4,273.96.
Loan Amounts And Repayment Periods
Personal loan amounts and repayment periods differ among lenders and loan types. Just because you're approved for a loan doesn't mean you should take it! Lenders are in the business of making money and may offer loans with high-interest rates or additional fees.
You should choose loan amounts and repayment terms that align with your financial capacity. Avoid taking on loans with repayment terms that are a stretch for you, as you'll risk late payments or defaulting on the loan, which can harm your credit score and future financial opportunities.
Fees And Additional Charges
Various fees associated with personal loans, such as origination fees, prepayment penalties, and late payment charges, can all add to the total amount you end up paying. It's essential to understand these fees and consider them compared to other loan offerings to choose the best option for your situation.
Loan Features And Benefits
Features or benefits offered by different lenders can include flexible repayment options, automatic payment discounts, or the availability of hardship programs. These perks mean you can pay back the loan on your own terms. Compare these offerings on different loan types before selecting a lender to find the best options for your situation.
Online Loan Comparison Tools
Online loan comparison tools that allow borrowers to input loan details and receive side-by-side comparisons. These tools can simplify your decision-making by providing clear insights into the differences between loan options. When you enter your details, you'll get an overview of the current best offerings, which you can compare to average rates and other online offers.
Optimizing Your Credit Score for Personal Loans
While the minimum credit score for a personal loan varies by lender, a higher credit score can help you save significantly. An optimal personal loan credit score is over 700, ideally 740+. However, even with a lower credit score, you can easily compare lenders online to find the most favorable terms and interest rates to get the loan you need while saving on interest and fees. Still in school? Check out the best personal loans for college students here. Or, find the best personal loans for excellent credit scores here.
Frequently Asked Questions
What is a credit score and why is it important for a personal loan?
A credit score is a number between 300 and 850 that takes into account your debt and repayment history to indicate to lenders the relative risk that you’ll default on a loan. The most common credit scoring system in the US is the FICO score. Lenders use your credit score to determine loan amounts you’ll qualify for and other loan terms like available interest rates.
What is considered a good credit score for obtaining a personal loan?
Generally, a credit score of 700 or above is considered good. Having a credit score of 700+ can increase your chances of qualifying for a personal loan with lower interest rates.
How can I improve my credit score to get a better personal loan?
You can improve your credit score to get a better personal loan by making on-time payments on all debt and paying off debt. You can also consider a secured credit card, credit-builder loan, becoming an authorized user, or using a rent reporting company to boost your credit score faster.
About Alison Plaut
Alison Plaut is a personal finance writer with a sustainable MBA, passionate about helping people learn more about financial basics for wealth building and financial freedom. She has more than 17 years of writing experience, focused on real estate and mortgage, business, personal finance, and investing. Her work has been published in The Motley Fool, MoneyLion, and she is a regular contributor for Benzinga.