A Personal loan is a form of credit that is generally issued by a bank, a credit union or a digital lender. This loan can help you make a big purchase, start a small business venture or even to bundle a high interest debt into a single lower interest debt payment that is much easier to manage. Personal loans can also be used to combine multiple credit card debts into a single and lower-cost monthly payment as they tend to have a lower interest rate than credit cards do. But we will only be focusing on how a personal loan can benefit your credit score.
Here are some ways in which a personal loan has a positive impact on your credit score.
1. Impact on Payment History
According to FICO, payment history makes up 35% of your total credit score. Which means that it is very important to have a good payment history and therefore a higher credit score. A personal loan can be a good thing for establishing and maintaining a good payment history and then eventually a good credit score. All you have to do is make your loan payments on time.
2. Impact on Credit Utilization
The Credit Utilization or Credit Utilization Ratio is the calculation of all your revolving debt divided by your credit limit. But as a personal loan is an installment based loan, it does not get considered in your credit utilization ratio. Your personal loan can have a positive impact on your credit score if you pay off the revolving debt you owe via the personal loan, decreasing your credit utilization.
3. Diversifies Credit Mix
According to FICO your credit mix makes up about 10% of your total credit score. Although this is a small amount in comparison to the debt you owe which is 30% and the payment history which is 35%, it can still help boost your credit score. This is because adding a personal loan to your debt mix shows that you can handle paying off an installment loan as well as handle a revolving credit loan, for example a credit card.
4. Allows for Debt Consolidation
Debt consolidation is when you take out one loan to pay off many others, bundled credit card balances. One of the upsides of taking out a personal loan is that it can be used to pay off consolidated debts and simultaneously boosts your credit score. This is because the interest rate on personal loans is much lower than on credit cards.
Getting a personal loan can take financial burden off your shoulders and helps you reach your financial goals faster. As long as you keep making monthly installment payments on time it will help you improve your credit score too. However, it is also important to remember that it is another debt after all and you have an obligation to pay it off. So only borrow the amount you need and make sure you have the resources to pay it off.