How Can a Personal Loan Increase Your Credit Score?
Last Updated : May 19, 2020, 6:42 p.m.
Credit scores are an everyday factor in our lives whether we are aware of it or not. How much you pay on your home mortgage or auto loan is impacted by credit rating. How much amount of loan you can avail from a bank and at what rate of interest is also determined by your credit rating. The better your rating is, the more credit you can avail and the lower interest rate you will have to pay. Knowing this, it will only make you improve your credit score. There is one way you can use to build your credit score is taking Personal loans.
A personal loan can be a great option to deal with your financial emergencies as it does not need any collateral and comes with easy formalities. It may be an expensive borrowing, but a personal loan, when managed smartly, can contribute in improving your credit score .
Before delving further into the importance of personal loan in increasing your credit score, let’s look at some factors based on which credit score is calculated out of 900. Here are the prime factors-
- Credit History
- Length of credit period
- Total debt owned
- Type of loans taken
- New debt
There are multiple methods for using a personal loan to improve credit score. Some of the important and less risky methods are outlined below. With all of these, it is essential to exercise good credit practices, like don’t borrow more than you need for your goal. consider automated payments to ensure that you don’t miss any payments. And most importantly don’t borrow what you can’t repay; this will lead to a downward spiral of bad credit and debt.
Debt Consolidation
This is one of the most popular and strategic uses of Personal loan to consolidate your debt. Imagine you have three credit cards, and have an outstanding amount on each one of them. You are making three different payments to three different lenders and at three different rates. What a personal does here is allow you to borrow money to pay off the outstanding money of three cards and then pay that loan back with a single EMI per month only to one lender. This technique also helps in saving your money in the process. This is just one simple example of using a personal loan to improve your credit score.
The potential gain from this technique is that personal loans usually have lower interest rates than credit cards. In this process of this debt consolidation technique, you will improve your credit ratings by making these payments and resetting the balance on your credit cards for further use.
Contributing to a better credit mix
Having a variety of credits helps to boost your credit score. Personal loan is an unsecured line that gets added to your credit report and making regular payment of an unsecured line helps you in increasing the credit score. If most of your credit is revolving credit, such as cards, a personal loan can enhance your credit mix.
Pay your old debts
Taking a personal loan to clear your old dues. This way you can be done with your old payments and can restart the debt payment with fresh terms. This also helps in improving your payment history, which untimely improves your credit score.
Repay on time
The first and foremost step that is taken to improve the credit score is by making payments on time. Whenever you apply for the loan, you pay it back in monthly installments, decided by the lenders basis their policies and your repayment ability. there is no burden hence you can make the payments easily on time, which will be a good addition to your credit history and will help in improving your credit score.
In addition to this, there are factors that you should keep in mind while taking a Personal loan to improve your credit score.
Do not apply for multiple Loans
You should not look like a credit hungry person to your lender. Also, a hard enquiry is initiated on your credit report every time you apply for a loan. It is advised to explore the options first then only take the best deal suitable for your needs. You should be aware of the fact that these hard enquiries impact your credit score and too many enquiries considered negative for a borrower.
Choosing the right amount to apply
Taking a personal loan is important but the amount is also considered important. Always take the amount that you need. Now since you are only taking it to improve your credit score, the amount of loan becomes a very important factor. Hence, assess the need then only take the personal loan.
Make payments on time
Taking a personal loan to improve your credit score will not make any sense if you will default in EMI payments or delay them. Credit cards and personal loans both being unsecured lines of credits, impacts your credit score if the payment is not done time. So make the habit of paying your EMIs on the due date.
Don’t Pre-pay the loan
If you have taken the loan for improving your credit score, then it is advised not to close your loan before it matures. A longer credit history is considered better. So if you keep making regular payments for a longer tenure, it will really help you out to maintain a healthy credit score.
Do not rush for other loans
As you start repaying the loan on time, your credit score will start improving in no time. This will make you eligible to apply for other loans as well. The offers will tempt you but we suggest you should not hustle for any other loans as you have started improving your credit score and it can impact your credit score in a bad way.
A personal loan is not always helpful in dealing with financial emergencies but it can also help in building a healthy credit score. Consolidate your debts or take a personal loan to pay off your debts.