A credit score is a crucial component of your financial health, and your relationship with loans has a direct and significant impact on it. Taking out and managing a loan can either build your creditworthiness or cause it to plummet. One of the ways loans can help your credit is by diversifying your credit mix. Credit scoring models look favorably on a borrower who can responsibly manage different types of credit, such as both installment loans and revolving credit cards. This shows a broader financial responsibility and can help boost your score over time.

Perhaps the most important factor is payment history, which has the greatest influence on your credit score. By consistently making your loan payments on time, you build a positive payment history that demonstrates financial discipline to lenders. This signals that you are a reliable borrower and can lead to a healthier credit score. To ensure you never miss a payment, setting up automatic payments from your bank account is a recommended strategy. On the other hand, late or missed payments will be reported to credit bureaus and can significantly harm your credit score, making it harder to borrow in the future.

Your credit utilization ratio, which is the amount of credit you’re using compared to your total available credit, is another factor influenced by loans. If you use a personal loan to consolidate high-interest credit card debt, it can lower your credit card utilization, which often leads to a higher credit score. However, taking on a new personal loan increases your overall debt, which can temporarily increase your credit utilization ratio. This might cause a small, temporary dip in your score, especially when combined with a “hard inquiry” from the loan application process. The key is to manage your debt responsibly so that the long-term positive effects outweigh any short-term negative ones.