How new loans affect credit scores
Loans – and how you manage them – are the most important factor in your credit. But credit is complicated, and depending on the condition of your loan, you may wonder if loans help or hurt your credit scores.
New and existing loans can affect your credit in many ways:
- They help you make a loan if you make payments successfully
- They hurt your loans if you pay late or default
- They reduce your ability to borrow (which may not directly affect your credit scores)
- They initially cause a slight injury to your loan, but they can easily recover if you make payments on time
Your credit is all about your history as a borrower. If you have borrowed and repaid loans in the past, lenders assume you will in the future. The more you did (and the more you did), the better.
Taking a new loan gives you the opportunity to repay and build your loan successfully. If you have bad credit – or have never been able to make a loan – it will improve with each monthly payment. See more details on how to make a loan.
Getting different types of loans also helps your credit. 10% of your FICO credit score is based on your “credit mix,” which looks at the different accounts in your credit report. If all your loans are credit cards, this might be fine, but your mix is better if you also have a car loan or a home loan.
Don’t just borrow to try to improve your credit. Just borrow wisely – if and when you need it – and use the right credit for the business.
Of course, these loans do you no good if you pay late or stop paying: your credit scores will decline quickly and you will have a harder time getting new loans.
The ability to lend
New loans drive more than your credit scores – they also reduce your ability to borrow.
Your credit reports show you every loan you currently use, as well as the monthly payments required. If you apply for a new loan, lenders will look at your existing monthly obligations and decide if they think you can afford the extra payment.
To do this, they calculate the debt-to-income ratio, which tells them how much your monthly income is eating up your monthly payments. The smaller the better.
You don’t even have to borrow to reduce your borrowing capacity. If you lend money to someone (helping them get approved based on your strong credit and income), that credit appears on your credit report.
You are 100% responsible for paying off the loan if the primary lender does not repay it, so lenders generally count it as a monthly charge (although you do not pay). New loans generally create a slight drop in your credit scores.
Borrow to reduce your borrowing capacity
If you have strong credit, that decline is probably short-term and insignificant. But, if you have poor credit (or built your credit for the first time), this decline can cause problems – so avoid saving your debt before applying for an “important” loan such as a home loan.
Every time you apply for a new loan, lenders check your loan. When they do, an “investigation” is created that shows that someone has withdrawn your credit. Inquiries can be a sign that you are in financial trouble and need money, so they pull your score a little. One or two queries are not a big deal, but a number of questions can damage your results.
If you’re going to shop among lenders – which is wise, and that’s the only way to get the best deal – make all your purchases in a relatively short time.
For example, if you are buying a home and comparing mortgage lenders, complete all your applications within 30 days or less (loan models give you a pretty generous window). For car loans, try to keep everything within two weeks.