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Can Personal Loans Increase Your Credit Score?

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By: Scam Risk - Expert Reviewer

Out of the many different kinds of loans, personal loans are one of the easiest to get and most versatile. They don’t require a high credit score or collateral and can be used for any legal purpose. They also give out quick funding, allow flexible payment options, and have lower interest rates than credit cards. 

This makes it a go-to for those who need emergency funding, couples looking for wedding funds, or those looking to consolidate debt. A personal loan and other types of loans are forms of credit. 

Whenever you use your credit card and pay back your bill on time, you can accumulate points in what is called a credit score. You are graded by banks or lenders based on your credit score using the FICO scoring system. 

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A credit score is a number between 300 to 850 and it shows lenders if you are to be trusted with their money. This score is based on your credit history, meaning, it reflects the amounts owed, payment history, credit mix, length of credit history, and new credit.

Why is this important? 

This is because credit scores help lenders determine the likelihood of getting their money back. A higher credit score will give them the idea that you are to be trusted with money, which in turn grants you better interest rates and terms. 

A credit score of at least 740 is considered high and will allow you to negotiate lower fees with your lender, allowing you to get a headstart on payments with the unused cash. It takes about a month to six months to build a credit score. 

There are many ways to increase your score but there are three easy ways to do it. 

The first is to make sure you are paying at least the minimum balance of your monthly dues. If you are having trouble doing this you may need to examine your expenses for any impulse purchases or unnecessary splurges. 

Second, make sure to consistently resolve delinquencies and keep your old accounts. While delinquent accounts should be settled as early as possible, old accounts should be kept open since closing them would lower your available credit. This could lead to an increase in your credit utilization ratio. 

Old accounts are also put into consideration in your credit score because credit age plays a part in its computation. It undoubtedly takes quite a while to increase but a single late payment can bring your score down very quickly. A single late payment can completely ruin a good score. So maintaining a good credit score is like having a report card with good grades – you get rewarded for doing consistently well. 

In connection with this, loans can affect your credit score either positively or negatively. Securing a loan is not a bad thing in itself but it does have an effect on your credit score. 

Does this mean that a personal loan could increase your credit score? 

Only you could answer that! 

You see, every time you obtain a loan, your outstanding debt increases and is recorded by the lending agencies as a new financial activity under your account. If, for instance, you decide to secure a new student loan while still paying for an existing car loan, your application may be rejected and your loan history reflects what credit agencies may consider as too much to handle. 

Temporarily, a personal loan may hurt or put a dent on your credit score but through consistent and timely payment, it will increase again in no time. The most important thing to understand is that your overall credit history has a much bigger impact on your credit score rather than what a singular new loan can do. If you have a long history of good debt management, the effect of your new loan on your credit score will likely be lessened. In fact, a loan that is settled on time may even boost your credit score and help build it. 

Aside from good payment history, your credit score could also increase if you take stock of your credit utilization ratio. This refers to how much you use your credit cards against your credit limit. If you charge too much to your credit cards – to the point of exceeding your credit limits, you risk getting a higher credit risk. If you want to keep track of your credit utilization ratio, gather the necessary information and compute for it. 

You can calculate the credit utilization ratio yourself using this process: 

  • Get the balances on all your credit cards and add them all up
  • Sum up all the credit limits on all your cards.
  • Divide the total balance by the total credit limit and multiply by 100 to get the ratio as a percentage. 

The smaller the ratio you arrive at, the better it is for your credit score. Experts recommend using not more than 30% of your credit card limit so you don’t let your credit score take a dip.

This just goes to show that maintaining a high credit score is essential to get lenders to trust you with loans. It’s important to do this because a strong credit will allow you to be able to borrow money. Especially with a pandemic ongoing, you will never know when an emergency might force you to apply for a loan. 

With that being said, you all the more have to be cautious with how you use your credit cards. Examine your spending habits and make sure to diligently pay your dues. Avoid impulse purchases, multiple debts, and make sure to check your bank statements every now and then to monitor your cash flow. 

Depending on your bank, you could also automate payments to be sure that you won’t miss a deadline. Always remember that it is easier to bring your score down than to bring it up. So you should always remain consistent!

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