Why is a personal loan good for your credit score?
People who take personal loans could increase their credit scores and can enjoy some of the following benefits:
- Lower APRs on loan products.
- Easier approvals when it comes to renting an apartment, applying for a mortgage, buying insurance, or getting employment.
Therefore, it could be a good idea to do everything you can to rebuild your credit, as your overall quality of life will improve. Some of the potential biggest benefits that taking out a personal loan can have on your credit score include:
- Improving the credit mix – Your credit mix is one factor that is taken into consideration when determining your credit score. It looks at all of the different types of debt that you have and essentially shows creditors that you are capable of managing different types of loans. People who have a diverse loan history are usually considered a lower risk for lending money.
- Building payment history – While you may think that taking out a personal loan would negatively affect your credit rating, it can have the opposite effect. By building a payment history and showing lenders that you are capable of managing debt and paying it off, you can begin to build a positive credit rating.
- Reducing credit utilization ratio – Your credit utilization ratio is calculated by dividing your credit card balance by your total credit limit and then multiplying by 100. This percentage will give you your credit utilization ratio and shows how much of your available credit you are using. The lower this number the better. A personal loan will allow you to pay off some of this debt and therefore reduce your ratio, improving your credit score.
- Paying off credit card balances – Taking out a personal loan will allow you to pay off credit card balances which usually carry a very high-interest rate. By reducing these balances you can save money by paying less in interest and also reduce your total debt loan and therefore improve your credit score.
- Using the loan to settle outstanding bills and other debts – If you have other loans or debts that need to be paid, obtaining a personal loan can help to pay these off as well. The fewer debts that you have, the higher your credit rating will be.
What Should You be Aware of When Taking a Personal Loan?
Taking out a loan is an excellent choice for improving your credit score and helping to pay off other debts but there are a few things that you need to be aware of when doing so.
- Higher Interest Rates – If your credit rating is already bad, taking out a personal loan may incur higher than normal interest rates. Since lenders view you as a higher risk for repayment, interest rates are set higher to reflect this risk. In the long run, this means that you will have higher personal loan monthly payments and end up paying back a considerable amount in interest, increasing the total amount of your loan substantially.
- Hard to obtain – Depending on your credit score, obtaining a personal loan can sometimes be extremely difficult. If your credit score is low, some lenders may not be willing to give you a loan easily or there may be stringent terms to the loan that make repayment difficult.
- More debt – It shouldn’t come as a surprise that when you obtain a personal loan, you are acquiring even more debt which may not be the best choice for someone who already has substantial debt and a poor credit rating. It is best to take a look at your situation and determine if you need another loan before applying.
Balancing Out Your Debt with What You Earn
To build your credit, it can help to take out a credit personal loan to consolidate debt, as you lower the amount of credit you are using (it should be below 30%) and can also reduce your debt-to-income ratio.
Pinpoint the Areas that Need Improvement
To build credit, it helps to review your credit score and credit report first. Doing so will enable you to pinpoint what you need to do to improve your rating. In some cases, if you are building your credit, you may not have much of payment history. By making regular payments on installments, you will increase your score, over time, and be able to apply for low-interest loans.
Assessing Your Payment History
What you don’t want to end up having are overdue payments on personal loan repayment or credit cards, as this type of information portrays you as credit risk. Moreover, your payment history can have the biggest negative effect on your credit rating, as this component makes up the largest percentage of your FICO rating.
What a Payment History Includes
Payment history will include the following factors:
- The amount of debt, which makes up 30% of the credit score calculation;
- The age of the credit accounts – creditors want to see a proven record of borrowing, and using and repaying credit (which makes up about 15% of the credit score);
- A good account mix – (making up about 10% of the credit rating) – creditors need to feel confident you can handle both revolving payments and installments; and
- The credit application history – several hard inquiries can make it look like you are overextending yourself.
All the factors that go into your credit history on your credit report will help you in your quest to build your credit and increase your score. Knowing this information beforehand will keep you on track on making regular monthly payments. It will also help you to use care when applying for credit or loans. When you create this type of portfolio, you can have a combination of revolving and installment credit loans that you can repay.v
Missing Out on Financial Opportunities
While building credit may not be currently part of your financial plans, it helps to make it a priority. When you don’t have good credit, you can miss out on several financial opportunities, such as getting a low-interest credit card or mortgage and using the interest you save on other investments.
Frequently, potential employers will check your credit for any accounts or delinquencies that may be in collections. They do this before they extend you an offer for a job. What if that dream job passes you by because of poor credit? That is why it pays to stay focused on building a good credit standing.
Therefore, building credit and having a good credit score lead to better approval rates for loans and credit products, lower interest rates, and better loan terms. You may even receive longer loan terms for a mortgage – such as 30 years instead of a 20-year fixed term.
Also, when you build your credit, you can get credit cards with benefits, such as payback rewards and credits on travel on dining.
Basic Ways to Build Credit
Building credit can be done in various ways. Some of these activities include the following:
- Repaying your credit card payments and loan payments on time
- Paying your utilities on time
- Maintaining a low credit card balance on your credit cards
- Making a personal loan repayment on time
- Opening a credit card for borrowers with little or no credit history
One Final Thought
Getting a personal loan and repaying it can effectively help you improve your credit rating and build credit. Use this approach, along with the other above suggestions, to ensure a better lifestyle for you and your family. Check out the personal loan products featured online today.