How is a credit score affected by applying for loans?

I’ve contacted my bank and asked them for a personal loan. They let me know I can borrow, however, before providing the interest rate they want to do a credit check that they say impacts my credit score. This feels like a catch-22. If they come back after the credit check with an insanely high interest rate, and I decline it, this just lowers my credit score. This is what the bank is telling me. Is this correct? If so, what is my best option for shopping for a low interest loan without taking a massive hit on my credit score?

Before we get into your communication with the bank, let’s talk a little bit about credit scores. A credit score is a value which indicates how much financial institutions trust you to pay back your loans. A credit score has a range from 300 (which indicates poor trust) to 900 (which indicates strong trust). A score of around 760 is in the median, meaning about half the population has a credit score higher than 760 and the other half are below 760.

Credit scores tend to go up when you pay your debts and bills on time, keep a low balance on any credit cards, and maintain active accounts (such as credit cards) for long periods of time. Failing to pay bills on time, having large balances on credit cards, and having no long-term accounts lowers the credit score.

You can usually learn what your credit score is, free of charge and without impacting your score, by requesting it from your bank. You can do this with most banks by signing into your account through the bank’s website.

As your bank’s representative suggested, applying for a new loan (which is called a credit inquiry) can lower your credit score. This is because shopping for a new loan suggests you need money for something and might be struggling to pay bills or debts. Whether this is true or not, it’s a flag that shows up on your credit report and may lower your score.

Now, is this a catch-22 or a problem? Usually not. Credit scores usually don’t have a big impact on your ability to get loans (or get loans at reasonable rates) unless your credit score is already really low. If your score is below 600 then it might be a challenge to get new cards or personal loans without collateral, but if you’re in the 600-900 range, you shouldn’t have any problems.

I’d also like to point out that requesting a new loan is likely to have a relatively small impact on your credit score. The exact amount will vary, but it’s probably going to be less than 60 points (out of a 600 point range), meaning a negative impact of 10% or less on your score. For comparison’s sake, the last time I took out a new loan, my score dropped 3 points (0.5%) and bounced back within a year.

You may be happy to know that once you get the loan and successfully make payments on it, your score will likely improve because you’ve demonstrated your ability to pay back your debts.

In short, what the person at the bank told you, about your credit score taking a hit by applying for a new loan was true. What they should have told you at the same time is this is almost never has a negative impact on you in any practical way and, after you pay back your loan, your credit score will bounce back.