Credit scores play a major role in many financial decisions, from qualifying for credit cards to getting favorable interest rates. Â Building or improving credit can take time, but small, consistent actions can make a difference.
When people think about personal loans, they may start by researching the average personal loan interest rate to decide if borrowing is a good idea. Read on to discover how getting a personal loan can even improve a personâs credit score.
Add a different type of credit
One of the factors used to calculate someoneâs credit score is the credit mix. This is a personâs unique combination of credit cards, loans, mortgages, and other types of credit. If someone only has credit cards, then itâs hard for lenders to assess whether theyâre capable of managing different types of debt. But if theyâve been able to pay off both credit cards and loans at the same time, this can reflect positively on their credit score. So, a personal loan that is repaid on time can boost an individualâs credit score by demonstrating they can balance a variety of different types of credit.
Lower credit utilization with debt consolidation
An individualâs credit utilization rate makes up 30% of their FICO score. This ratio shows how much available credit the individual is currently using. So, if they have many credit cards that they are maxing out each month, then theyâre using a significant amount of their available credit.
Some people use a personal loan to pay off those balances and then make one fixed payment each month instead. This may lower how much available credit is used on cards, which can be a factor in your credit score (though it may impact the credit mix).
This works because the credit utilization rate only considers peopleâs revolving credit, such as credit cards or personal lines of credit. Installment credit, such as mortgages or personal loans, is not included in the calculation. So, by moving credit card debt balances into a personal loan, people can lower their credit utilization rate and increase their credit score. When considering this decision, many people search âwhat is a good interest rate?â, since the interest rate of the new loan affects whether debt consolidation makes sense for their financial situation. Ideally, the personal loan used to pay off credit cards would have a lower interest rate than the credit cards being paid off. But many people find a repaying installment terms easier to manage than credit card terms, or they appreciate repaying a single lender instead of multiple companies.
Build payment history
Making payments on time is one of the most important parts of building credit.
Lenders want to know if the person receiving the loan is trustworthy and how effectively theyâve paid off debt in the past. One of the easiest ways people can improve their credit score is to repay debt on time.
Personal installment loans are repaid in equal payment amounts on a fixed schedule, which helps with budgeting and planning. As long as the lender reports to credit bureaus, they are an excellent way to help build payment history over time. Staying consistent with those payments may help show a history of responsible borrowing.
The bottom line
A personal loan can be a useful tool for anyone trying to build or improve their credit. By helping with credit mix, lowering credit utilization, and building up an on-time payment history, it can make a real difference in approximately six months.
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Name: Sonakshi Murze
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