Taking out a loan can be an excellent way to build or improve your credit history. However, not all loans will help you improve your credit score. Before you apply for a new loan, it’s important to understand how different types of loans affect your credit and the advantages and disadvantages of using a loan to improve your credit score.
Choosing the Right Kind of Loan
For a loan to potentially boost your credit score, it needs to have an impact on your credit. Some loans don’t impact your credit score such as payday loans. According to GreenStarCash, most payday lenders run a soft credit check that doesn’t affect your credit score or show up on your credit history to anyone but them. Additionally, payday lenders usually do not report payday loans to national credit agencies. This means that a payday loan will not improve your credit score even when you make your payments on time.
To improve your credit score with a loan, you will need to acquire an installment loan that will appear on your standard credit report.
Improving Credit With a Personal Loan
Whether you are new to having credit or not, a personal installment loan could help you boost your credit score. You can use the loan to build your credit history or consolidate old debt. Personal loans often have lower interest rates than credit cards and can be used for a variety of purposes including living costs and emergency expenses.
Building Credit
A key factor in the calculation of your credit score is the age of your credit history. If you don’t have many loans or credit cards, you may have a young credit history. Getting a personal loan can help establish your credit history and allow you to prove that you can make regular payments on time.
If you are still building your credit history, consider a secured loan. A secured loan is a loan that a lender gives you in exchange for collateral such as a house, car, or money. A credit-builder loan is one type of secured loan. It’s a great option if you don’t need extra money right away but want to use the loan solely to increase your credit score because you won’t receive the loan money until after you have paid off the loan.
Having multiple lines of credit can also boost your credit score particularly if you don’t have a long credit history. If you already have a credit card, adding a personal loan to your credit profile will diversify your credit history.
Consolidating Debt
A personal loan can help you improve your credit score by consolidating credit card debt into more manageable monthly payments. This can improve your credit score by ensuring that you can make all your payments on time. Payment history is a major factor in your credit score, so if you are struggling to make credit card payments on time, a debt consolidation loan may be a good choice for you.
A debt consolidation loan can also lower your credit utilization ratio. A credit utilization ratio is the amount of credit you are using divided by the total amount of credit you have available. This only applies to revolving credit such as credit cards and not installment loans such as secured and unsecured personal loans.
By transferring some or all of your credit card debt to a personal loan, you’ll increase the amount of available revolving credit you have and subsequently decrease your credit utilization rate. When your credit utilization rate decreases, your credit score may go up. It’s recommended to keep your credit utilization rate below 30%.
Weighing the Pros and Cons
There is a balance to using a personal loan to improve your credit score. Taking out a new loan may temporarily decrease your credit score because it will add a hard inquiry to your credit report. Each hard inquiry may decrease your credit score up to ten points. Therefore, it is not recommended to apply for multiple loans at once. Instead, research different personal loans and get pre-approved when possible without a hard inquiry before making your final decision.
When using a personal loan to improve your credit score, it’s important to make all your payments on time. Making a payment late or missing a payment could negatively impact your score. Luckily, some lenders are willing to work with you. If you are struggling to make a payment on time, contact your lender right away and see if they have extension options or options to lower your recurring payment amount.
Parting Words
A personal installment loan can diversify your credit report, lower your credit utilization ratio, and potentially make your payments more manageable. When applying for a personal loan, make sure to choose one that directly affects your credit score such as a credit-building loan or a debt consolidation loan. Don’t apply for more personal loans than necessary and remember to make all your payments on time to see the biggest possible boost in your credit score!