Improving credit scores can take an arsenal of strategies. Common strategies consumers find most successful are making on-time payments, reducing debt, disputing or settling collection accounts and even requesting a goodwill removal of negative marks from a creditor.
But one strategy is often overlooked – getting a personal loan. Personal loans are the fastest growing type of loan – and they could help save you money and improve your credit scores. A personal loan can help build a good credit score, as well as foster financial responsibility.
What is a personal loan?
A personal loan is an unsecured loan with a fixed interest rate that is typically repaid over a number of years. Unsecured loans are issued without the need for collateral and are based on the borrower’s creditworthiness.
Depending on your credit profile, you may be able to qualify for a low-interest rate personal loan but if your credit is shaky you may only qualify for a personal loan for bad credit. Personal loans for bad credit will likely have a high-interest rate.
5 Ways a personal loan can help improve scores
- Demonstrate Creditworthiness. When rebuilding credit scores it is important to have current positive credit reporting. Open and active accounts are scored more highly than closed accounts because they demonstrate that you are managing credit well now and not just in the past. In addition to credit cards, a personal loan will help build a strong credit history and credit scores.
- Debt Consolidation. A popular and good use of a personal loan is to consolidate multiple debts into one debt, which may reduce the risk of multiple delinquencies appearing on your credit report if you have multiple credit accounts. Paying down debt will reduce your debt-to-limit ratio on credit accounts. The lower your utilization, preferably 10% or less, the higher your credit score.
- Installment debt vs. Revolving debt. Credit cards are considered revolving loans and have no fixed repayment term. Personal loans are considered installment loans, which means they carry a fixed repayment term. Most credit scoring models penalize you for using more than 30% of your available credit limit on revolving debt (credit cards). But in most cases, the balances on your installment loans (personal loans) aren’t factored into this ratio. Paying down installment loans is a good sign that you’re able to repay debt but installment loans have a much smaller impact on this portion of your credit score. If you have high credit card debt your credit scores will suffer. The closer you are to your credit limit, the lower your credit score. When you swap credit card debt for a personal loan, you can lower your credit utilization and improve your scores.
- Credit Mix Improved. FICO, the most widely used credit scoring system, likes to see a good credit mix which includes revolving credit such as credit cards along with installment credit such as a personal, auto or mortgage loan. The credit score considers the mix of different types of accounts on your credit scores, and ideally you want to have both installment and revolving accounts listed.
- Lower interest. Personal loans typically have a much lower interest rate than credit cards. You may be able to save some extra money or even put more money towards reducing debt.
Finding a personal loan when you have bad credit
The best place to start is your bank or credit union. Even if your credit is less than perfect a good banking relationship may allow you to borrow. Another source of personal loans for less than perfect credit is Springleaf which accepts applications from consumers with a minimum credit score of 600 or above.
Alternatives to a personal loan
- Zero Balance Transfer Card. People with good to excellent credit may want to consider paying off existing credit card debt with a zero interest balance transfer credit card. But this option should only be visited if you can pay off the balance transfer card within the 0% interest time period, typically 12 months to 18 months.
- Home equity loan. If you own your home, a home equity loan is usually a lower cost option. However, unlike a personal loan, a home equity loan is a secured loan so that means your home serves as collateral and can be claimed by the lender if you default.
- Credit builder loan. A secured personal loan without an upfront lump sum of money needed.