A good credit score is a very important aspect of your credit, however maintaining so is not a very easy task. It may be slightly hard to believe that a personal loan can help you a great deal in improving your credit. Even though a personal loan implies more debt and may seem to be negatively impacting your credit. However, it can good for you if you use personal loans to restructure your debt.
Getting a good mix of credit helps you keep a healthy credit score, but you should not go overboard with too many types of credit. As in the case of personal loans, you are required to make a fixed monthly payment. The pre-determined monthly payment includes interest plus a part of the principle. Sometimes a personal loan at a lower interest rate can help you pay off credit cards debt with high interest rates.
Benefits of taking a personal loan to improve your credit score
Clear existing high-interest debts: If you haven’t paid your past loan dues and have frequently missed paying your installments, the penal interest will be high, as well as the interest on the credit debt or unpaid loan. Availing a personal loan with a lower interest to clear your debts will reduce your financial burden and improve your credit score.
Consolidation of debts : You could use one personal loan to consolidate your debts. This will reduce the interest you’re paying for your debts and will ensure that your repayment will be systematic through the EMIs of the personal loan.
Above all, paying your personal loan on time will eventually improve your credit score even if you’ve had past credit debts or unpaid loans.
What you should keep in mind when availing a personal loan to improve your credit score
Do not make multiple personal loan applications: If you wish to consolidate your debts using a personal loan, choose a bank offering a loan that will suit your finances and if you’re sure that you will be eligible for the loan. Making multiple personal applications could backfire as every personal loan rejection will reduce your credit score and your overall chances of availing a loan.
Choose a personal loan amount you’re comfortable with: Since your key intention is to clear your debts, choose a loan amount that you can repay easily through the set installments. To have a clear idea, use an EMI calculator to know how much you would financially need to pay the EMIs.
Calculate the EMI:NMI ratio : Once you’ve calculated the EMI, ensure that the EMI amount is not more than 40-50% of your net monthly income.
Avoid foreclosure of the personal loan: If you wish to improve your credit score, ensure that you make regular payments through the tenure of the loan. This will ensure that you have a longer credit history as well.
Choose the lender and the loan amount wisely: Make a comparative analysis of financial lenders offering personal loans. Choose a lender with a good reputation and offering personal loans at lower interest rates.
- How the credit score is decided: With 750 being a good credit score, 900 excellent, and anything below 600 being considered poor, listed below are several factors that decide your credit score:
You credit history: This factor takes into consideration your repayment history and your reliability in repaying a personal loan.
The length of the loans or credit: The period of your loan or credit relationship with a lender is taken into consideration as well. The longer the period, if you have made regular repayments, the better are the chances of you having a good credit score.
Total amount of your debts: The total amount of your debts and credit dues directly affects your credit score as well. If you have a high outstanding balance to be repaid, your credit score will take a hit.
The type of loan you’ve taken: If you’ve failed to repay your home loan or personal loan on a regular basis, this will have a bigger impact on your personal loan as compared to failing to pay your credit dues for a month or two.
Current loans: The repayment history of your current loan will be taken into consideration as well.
Using Personal Loan to your Advantage
It is very tempting to spend the newly acquired credit through personal loans, but doing so will only negate your purpose of improving credit.
- The best way to use the acquired fund is to pay off credit card debts, if any. However when you pay off your credit card, it is advisable not to cancel the cards and retain them to continue to benefit from your credit.
- Apart from this, if you continue to make payments on time for six months to a year, there is a possibility that you can get your loan refinanced at a much lower rate of interest.
- A personal loan also improves your available credit to debit ratio. Also referred to as the ‘utilisation ratio’ is responsible for 30% of your credit score.
- A personal loan can help create a good mix of your credit and help you gain a good credit score.
- Personal loans can also help in lowering your debt faster as you can choose shorter loan tenures.
The most important step in securing a personal loan is to find one with the best interest rate as there are many lenders and banks available offering a wide variety of rates. However, multiple applications to multiple lenders may reflect badly as it may be a sign that you want to take on a large debt.
Remember, there is a downside to this technique of credit repair if you do not make decisions carefully. In the initial phase, when you take a new loan, there may be a fall in your credit score as a new loan signifies additional risk. You should keep in mind to make timely payments always and avoid opening any other new account.