Can Too Many Installment Loans Hurt Your Credit?

More than half of American adults hold at least one misconception about how credit scores are calculated. Misinformation isn’t the only challenge to understanding the best ways to maximize your credit, either. Most credit building tools, such as credit cards and installment loans, can be both good and bad depending on how you use them.

Fortunately, making loans work for you doesn’t have to be difficult. Here’s what you need to know about using installment loans to build credit without dragging down your score.

What Are Installment Loans?

Put simply, an installment loan is any loan that you pay off in set intervals. The category includes, among others:

• Auto loans
• Mortgages
• Personal loans

Can an Installment Loan Help Me?

Credit building strategies often recommend installment loans for bad credit because they can be an excellent vehicle for:

• Building a credit record if you don’t have one
• Repairing or improving a low credit score
• Bumping up a good score even more by diversifying your credit mix

How an Installment Loan Can Improve Your Credit Score

Most credit scoring companies use the same basic calculations to determine your score. They base their ratings on five main factors:

• The total amount of money you owe to all lenders
• The length of your credit history
• Your payment history
• Your credit mix
• New credit accounts

Of these, your payment history carries the most weight. It accounts for around 35 percent of your total score.

This means that taking out one or more loans and reliably paying them on time every month is a simple and powerful way to build a strong credit score.

In fact, many banks offer credit building loans specifically to help young people start building credit early. In these loans, borrowers take the money they receive and put it in a separate bank account. They then use that money solely to pay off the loan over time.

This can not only provide a strong payment history but help individuals get an early start on their credit history, which further improves their scores.

Credit Mix

Loans can also improve your score by diversifying your credit mix. If you have multiple credit cards but no loans, your credit mix is unbalanced. That can drag your score down.

Taking out a personal loan, perhaps to pay off some of that credit card debt, diversifies your credit mix and pushes your score up.

How an Installment Loan Can Hurt Your Credit Score

Applying for installment loans online or in person can generate credit inquiries. “Soft” inquiries do not tend to affect your score. “Hard” inquiries, such as those that lenders put through when you formally apply for a loan can temporarily drive your score down by around five points each.

For best results, shop around before applying and keep actual applications to a minimum.

Also, keep in mind that taking out too much debt in any form can be a problem. Try to balance your debt between loans and credit cards and never take out so much that you can’t meet your monthly payments on all accounts.

Making Smart Financial Choices

Learning how to use installment loans wisely is only one of many ways to boost your credit score. Check out our other great articles today for more strategies you can apply to achieve the best possible results in the least amount of time.