How to use a personal loan to increase your credit score

A personal loan can be a valuable financial tool to pay off debt. Whether it’s paying for an unexpected medical bill or consolidating high-interest debt, there are many possible uses for this type of unsecured loan.

In addition to helping you cover unforeseen expenses, personal loans – in addition to an auto loan or student loans – can also impact your credit score. Here’s the catch, though — they can have both positive and negative impacts. So before you apply, it’s important to consider the potential effects.

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How to use a personal loan to increase your credit score

There are several ways that a personal loan can help improve your score:

1. Credit mix

Adding a personal loan to your credit report can diversify your credit mix. Your credit score benefits from having a healthy variety of types of debt, like installment loans, credit cards, and mortgages. Your credit mix only makes up 10% of your credit score, but it can make a difference.

2. Credit utilization

Using a personal loan for credit card debt consolidation can improve your FICO score by reducing your credit utilization. Your credit utilization is the percentage of available credit you’re currently using. This factor makes up 30% of your credit score and can negatively impact it if you use more than 30% of your available credit. By moving your debt to a personal loan and clearing up space on your credit card, you reduce your utilization.

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3. Payment history

The most significant factor affecting your credit score, making up 35%, is your payment history. In other words, credit bureaus want to see that you can make your payments on time each month. Borrowing a personal loan and making your payments on time without a late payment can improve your payment history and boost your credit score – from bad credit, to fair credit and onto good credit – especially if you don’t have many other accounts on your credit report.

If you’re considering applying for a personal loan, make sure to check your credit score ahead of time. Not only will you see whether your current score will qualify you for the best loan rates, but you’ll also see which areas of your credit report could use some improvement. You may just find that a personal loan could help to fill those gaps.

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Will a personal loan hurt my credit?

A personal loan can undoubtedly benefit your credit score, but it’s also important to consider the ways it might hurt your score:

1. Hard inquiry

When you apply for a personal loan – or any debt for that matter – you’ll have a hard inquiry on your credit report, which can negatively impact your score. Hard inquiries usually only have a minor impact, and your score is likely to bounce back up after a few months. However, the impact can be greater if you open several new debt accounts in a short amount of time.

2. Length of credit history

The average length of your credit history makes up 15% of your credit score, and, in general, a longer history is better for your score. Taking out a new debt will reduce your average length of credit and could therefore lower your credit score.

3. Additional debt

Many people use debt consolidation loans to manage credit card debt. But if you have a spending problem, opening up the space on your credit cards might just result in more spending. Not only will you further hurt your credit score, but you could find yourself in a situation where you can no longer afford your debt payments.

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What should I look for when getting a personal loan?

When it comes to finding a personal loan, your goal should be to find the best deal and loan terms that best suit your financial situation. Important factors to consider are:

• Interest rate: What lender is willing to offer you the lowest rate?
• Loan terms: Over how many years do you want to pay off the loan?
• Fees: Many lenders offer personal loans with no fees, so be wary of those with excessive fees.

DO THESE 5 THINGS BEFORE CHOOSING A PERSONAL LOAN LENDER

What’s next?

Taking out a personal loan will almost certainly have an impact on your credit. But depending on your situation, it’s likely to have both positive and negative effects. As you shop for a personal loan, be sure to consider not only the credit implications, but how you can find the loan that best fits your personal finance needs.

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