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Taking out a personal loan can both help and hurt your credit. In the short term, applying for a new loan can have a small, negative impact on your scores, due to the hard inquiry by the lender. If managed well, however, having a personal loan can boost your credit profile over time by adding to your positive payment history and broadening your credit mix. This could make it easier to get approved for loans and credit cards with attractive rates and terms in the future.

Here’s a closer look at how personal loans affect your credit score, both positively and negatively, plus guidelines on when it makes sense to take one out.

How Is Your Credit Score Calculated?

Understanding how personal loans impact your credit starts with knowing how your credit score is calculated. The most common credit scoring model, FICO®, uses five components to calculate your score. Here’s a look at each factor and how much weight it’s given in FICO’s calculation.

•   Payment History (35%): Your record of making on-time payments to lenders is the most important component of your score. This helps creditors determine how much risk they are taking on by extending credit.

•   Amounts Owed (30%): This includes the total amount of debt you currently have and your credit utilization ratio, which measures the percentage of available credit you’re using. If you’re tapping a lot of your available credit on your credit cards, it suggests you may be overextended and, thus, at higher risk of defaulting on a loan.

•   Length of Credit History (15%): This factor takes into account the average age of your accounts, the age of your oldest account, and how long it has been since you used certain accounts. Generally, having a longer credit history can positively affect your score.

•   New Credit (10%): A small but still important part of your score is how much new credit you’ve recently taken out. Opening new accounts or having too many credit inquiries can temporarily lower your score.

•   Credit Mix (10%): Your credit mix looks at how many different types of credit you hold. Having a variety of credit types — like credit cards, retail accounts, and installment loans — can positively affect your score.

A personal loan can influence several of these factors, for better or worse, depending on how you manage it.

How Do Personal Loans Work?

A personal loan is a lump sum of money borrowed from a lender, such as a bank, credit union, or online lender. Personal loans are typically unsecured, meaning you don’t need to provide collateral (like your car or home), and can be used for various purposes like consolidating debt, covering medical bills, or funding a wedding.

When you take out a personal loan, you agree to repay it in fixed monthly installments over a predetermined period, usually ranging from two to seven years. The interest rate, determined by your creditworthiness, and any lender fees affect how much you’ll pay in total.

Recommended: Is There a Minimum Credit Score for Getting a Personal Loan?

Ways Personal Loans Can Hurt Your Credit

While personal loans can be beneficial, they also have the potential to harm your credit. Here’s how:

Requires a Hard Credit Inquiry

When you apply for a personal loan, the lender typically performs a hard credit inquiry to evaluate your creditworthiness, which can adversely impact your credit score. Hard inquiries remain on your credit report for two years. However, their negative effect on your score is minor (typically 5 points or less) and lasts only about a year.

Note that prequalifying for a personal loan, which involves a soft inquiry, won’t have any impact on your score. This can give you an estimate of the interest rate and loan amount you can expect in a loan offer.

Can Increase Overall Debt

Taking out a personal loan can increase your overall debt, which can negatively affect the “amounts owed” component of your credit score. This may cause you to see a slight drop in your score. However, if you’re consolidating credit card debt, you will reduce that debt by paying it down with the personal loan, and your amounts owed won’t be impacted.

Can Negatively Impact Payment History If You Miss a Payment

Since payment history is the largest factor in credit scoring, missing just one payment on your personal loan can result in a substantial drop in your score. While being just a few days late may not affect your credit, lenders can report payments that are more than 30 days overdue to the credit bureaus. Late payments remain on your credit reports for seven years.

Setting up autopay or reminders can help ensure you make your payments on time and avoid this credit score setback.

Can Shorten Your Credit History

Taking on a new loan can shorten the average age of your credit accounts, which could have a small negative impact on your score. Generally, a longer credit history is considered better than a shorter one.

How Personal Loans Can Help Your Credit

Despite the risks, personal loans can also positively influence your credit when managed wisely. Here’s how:

Can Add to Your Credit Mix

Your credit mix accounts for 10% of your score. Adding a personal loan to your portfolio — especially if you primarily have revolving credit, like credit cards — can enhance your credit profile by showing that you can manage different types of credit responsibly.

Can Improve Your On-Time Payment History

Consistently making on-time payments on your personal loan demonstrates financial responsibility, which can strengthen your payment history — the most significant component of your score. It may take a few months for the benefits to show up but over time, this can positively impact your credit.

May Help Lower Your Credit Utilization Ratio

If you take out a personal loan to pay off high-interest credit card debt (also known as a credit card consolidation loan), you can lower your credit utilization ratio, which is the percentage of your available credit you’re using. A lower ratio — ideally under 30% — is generally beneficial for your credit. However, this strategy only works if you keep your credit card spending low after paying off your balances with the loan.

When to Consider Taking Out a Personal Loan

Even though applying for a personal loan may result in a small, temporary drop in your credit score, there are times when taking on this type of debt can be a smart financial move. Here are some scenarios where you might consider getting a personal loan.

•  You want to consolidate high-interest debt: Personal loans typically have lower interest rates than credit cards, making them an attractive choice for paying off expensive credit card debt. An online personal loan calculator can help you determine how much you could potentially save. If you’re juggling several credit cards, a debt consolidation loan can also simplify repayment.

•  You’re facing unexpected expenses: Medical bills, home and car repairs, or other emergencies can sometimes justify taking out a loan. Using a personal loan may be more cost effective than putting these expenses on your credit card.

•  You have good or excellent credit: The best personal loan interest rates are generally reserved for borrowers who have strong credit. While there are personal loans for bad credit, they typically come with higher interest rates and other less-than-ideal terms.

•  You earn a steady paycheck: Getting a personal loan generally only makes sense if you have a regular income and earn enough to comfortably cover the monthly payments for the term you select.

The Takeaway

Personal loans can have a positive or negative impact on your credit depending on how you manage them. Initially, applying for a personal loan can slightly downgrade your score. This is due to the hard inquiry, as well as the loan’s impact on the average age of your accounts and (potentially) your overall debt load. However, if you repay the loan responsibly, having a personal loan can ultimately help your credit by adding positive payment history, diversifying your credit mix, and — if you use it pay off credit card debt — reducing your credit utilization rate.

Before taking out a personal loan, you’ll want to assess your financial situation, shop around for the best rates and terms, and make sure the monthly payments work with your budget.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

FAQ

Is a personal loan bad for your credit?

A personal loan isn’t inherently bad for your credit, but its impact depends on how you manage it. Initially, applying for a loan may lower your score slightly due to the hard credit inquiry. In addition, taking on more debt can increase your amounts owed, which might affect your score. However, consistently making on-time payments can boost your payment history, a major factor in credit scores. And if you use a personal loan to consolidate credit card debt, you’ll lower your credit utilization ratio (how much of your credit limit you are using), which can positively impact your credit.

Will a personal loan affect my credit card application?

It can. If you applied for the loan recently, the hard credit inquiry may have slightly lowered your credit scores. Having a personal loan can also lower the average age of your accounts and, potentially, increase your debt load, which can negatively impact your credit. Over time, however, having a personal loan can improve your credit profile by adding to your positive payment history and, if you use it to consolidate credit card debt, lowering your credit utilization, making it easier to get approved for a credit card.

Will a personal loan affect my car loan application?

It can. When assessing your eligibility for a car loan, lenders typically consider your credit score, debt-to-income ratio, and overall financial profile. The hard credit inquiry for the personal loan might lower your credit score temporarily. In addition, the added debt from the loan could increase your debt-to-income ratio, making you appear higher risk to a lender. On the other hand, responsible repayment of the personal loan shows financial discipline, which can improve your credit profile over time. Ultimately, this could make it easier to get a car loan with attractive rates and terms.

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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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“What happened?!” may be your response when you look at your paycheck and see all of those deductions, whittling your hard-earned cash down to a (much) lower figure than you expected.

And perhaps, if you look more closely, you’ll notice a line on your paystub that shows a major amount of money subtracted and think, What is withholding tax? And why do they take so much?

Federal and state withholding taxes, also known as “taxes withheld,” are funds that your employer takes out and sends to the government to help federal programs. These taxes have a purpose, and in the long run, you’ll probably be glad they are deducted from your check rather than owed as a mega lump sum on Tax Day.

Read on to learn more about tax withholding, including factors that impact how much gets deducted and how to calculate your withholding taxes.

What is Income Tax Withholding?

Many people think their taxes are due mid-April, but the Internal Revenue Service (IRS) actually requires you to pay as you go, meaning you need to pay most of your tax during the year, as you receive income, rather than at the end of the year. When you see those federal and possibly state and local taxes being whisked out of each paycheck, that’s exactly what is happening.

A withholding tax is an amount, based on your salary, that your employer sets aside and then pays directly to the government on your behalf. It’s a credit against the full amount of personal income tax you will owe for the year. By doing this, your employer is helping you avoid a surprise tax bill come April. Tax withholding also helps ensure you won’t owe interest or a penalty for paying too little tax during the course of the year.

That said, how much is deducted from your paycheck can vary depending on a variety of factors. You are able to designate what portion of your check goes toward your taxes on the IRS W-4 form (more on that in a bit).

•   If you allocate too much, that means more than necessary is taken out, and you will likely receive a tax refund when you file your taxes.

•   If you set aside too little, you will probably owe a balance or have what’s known as a “tax bill” due during tax season to make up the difference.

Your federal withholding tax rate depends on your income and tax bracket.

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Factors That Determine Tax Withholding

There are several factors that determine just how much tax is withheld from your paycheck, whether it arrives as a paper check or via direct deposit. These include:

•   How much you earn: Generally, the more you earn, the higher the rate at which taxes are withheld

•   Your filing status: For instance, you might file your taxes as single, married filing jointly, or married filing separately.

•   How many (if any) withholding allowances you claim: Typically, if you claim a higher number of allowances, your withholding will be lower. This means more cash will flow your way on each payday, but you might owe taxes when you file. If you have a lower number of allowances, more money is taken out for taxes, and you could wind up getting a refund when your tax return is processed.

•   Whether you decide to have additional money withheld: Some individuals may ask their employers to withhold, say, an extra $100 or more per pay period if they find they typically owe taxes at year’s end.

Recommended: How to Reduce Your Taxable Income

What Is State Income Tax Withholding?

If you live in a state that levies income tax, you will also see tax withholding for that type of tax on your paycheck. There are just nine states that don’t tax earned income. In other words, you will not pay state taxes if you live in:

•   Alaska

•   Florida

•   Nevada

•   New Hampshire

•   South Dakota

•   Tennessee

•   Texas

•   Washington

•   Wyoming

The concept of tax withholding works in the same way at the state level as it does at the federal: A certain portion is put toward your future state tax bill, and you may either owe or get a refund, depending on how much you paid in.

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What Is the Purpose of Tax Withholding?

As briefly mentioned above, tax withholding saves you from owing a huge bundle of taxes in April. If people were left to their own devices to set aside money for taxes, well, that might not always be a success. Every time you receive your paycheck, there are bills to pay, dinners out and movies to tempt you, and vacations to plan and take. As a result it can be hard to save money from your salary.

In addition to helping you avoid a surprise tax bill, tax withholding is also a way for the government to maintain its pay-as-you-go income tax system. If you pay too little in taxes throughout the year, you can get hit with an underpayment penalty and interest payments (on top of that surprise tax bill).

Recommended: Your Guide to Filing Taxes for the First Time

Tax and Employment Documents to Know

When you are first hired at a company, you typically fill out a W-4 form. This form is designed to help your employer estimate how much tax you’ll owe by the end of the year. To do this, the form asks you about your family, potential deductions you might claim, and any additional income you earn outside your W-2 job. Based on your answers, your employer will determine how much tax to withhold from your paychecks.

Then when tax time rolls around, you will receive IRS Form W-2. This includes information on how much income you earned in a given tax year, as well as how much you paid in federal, state, and other taxes.

You’ll use this W-2 to file your taxes, and it will determine whether you receive a tax refund, owe more taxes, or break even.

Calculating Income Tax Withholding

It can take a bit of tweaking to find that balance between overpaying in federal withholding and having to pay more when you file your taxes.

Some people like getting a tax refund because it’s a lump sum they can put toward debt or invest. But realize that overpaying is a bit like giving the government a free loan throughout the year.

While there may be fast ways to get a tax refund, perhaps you’d rather just hold onto that money in the first place. If you better balance what is taken out of your paychecks, you could take the excess you would have paid and put it in a high-yield savings account or invest it for the future.

If you’re wondering what is a withholding tax allowance that’s right for you, there’s help. The IRS has a Tax Withholding Estimator you can use based on your current situation. In general, the more allowances or exemptions you have, the less will be withheld from your pay; the fewer the exemptions, the more will be withheld.

While you aren’t asked to fill out a new W-4 each year, you may request one if you think you need to adjust the withholding amount.

Some of the times it might be wise to adjust how much income tax is withheld include:

•   Starting a new job or position

•   Having a child

•   Getting married or divorced

•   Buying a house.

Can I Be Exempt from Tax Withholding?

To be exempt from tax withholding means that no federal taxes will be withheld from your pay. You might also have no state or local taxes (if applicable) deducted. Here are the ways in which someone might qualify to be exempt from such taxes:

•   If all of your federal income tax was refunded because you have no tax liability and you expect the same thing to happen this year, then you may be exempt from withholding taxes. (But note, Social Security and some other taxes may still be withheld as part of other types of payroll deductions.)

•   Certain types of income are considered exempt. For instance, money paid to foster parents for their taking care of children in their homes may be tax-free. Payments from workers’ compensation is another example of funds that may be tax-exempt.

The Takeaway

Paying taxes may not be fun, but it’s important to remember that this money is put toward things we all enjoy, like smooth roads and education programs. And federal withholding from your paycheck keeps you from having a giant bill when you file taxes.

When it comes to tax withholding, it’s important to understand how much is being withheld from each paycheck and whether you need to modify your W-4 to find a better balance between overpaying and owing more money come Tax Day.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

FAQ

Does the government pay for income tax withholdings?

Money that is withheld from your earnings, known as income tax withholding, goes to the government. These dollars help pay for federal programs that benefit citizens and keep our country running, from education to transportation to security.

How can someone qualify for a withholding exemption?

To qualify as tax-exempt, you would have to have had no tax liability in the previous year and expect the same status in the current tax year. Also keep in mind that some forms of income may be tax-exempt, such as payments for in-home foster care of children or for workers’ compensation.

Why has my employer withheld too much income tax?

If your employer withheld too much income tax, then you will likely get a refund at tax time. You can update your withholding on your W-4 form; the more allowances you have, the less money will be withheld to cover your tax liability.

Why has my employer withheld too little income tax?

If you wound up owing the IRS money at tax time, the issue could be that you have too many exemptions or allowances claimed on your W-4 form, meaning your employer is not withholding enough money from your paycheck. You may want to adjust your W-4, knowing that the lower your number of allowances, the more money your employer with withhold and send to the IRS on your behalf.

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SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

We do not charge any account, service or maintenance fees for SoFi Checking and Savings. We do charge a transaction fee to process each outgoing wire transfer. SoFi does not charge a fee for incoming wire transfers, however the sending bank may charge a fee. Our fee policy is subject to change at any time. See the SoFi Checking & Savings Fee Sheet for details at sofi.com/legal/banking-fees/.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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