Guest Post by Andrew Rombach
Your credit score might be one of the most important pieces of data about you. It’s used to determine not just your creditworthiness, but in some cases your dependability and likelihood of keeping to certain obligations. Many jobs now include a credit report as part of their pre-employment background checks, and your credit score is a factor in everything from renting an apartment to getting auto insurance.
Today, the average credit score in the United States is 687 which is considered OK. However, there’s definitely room for improvement as scores over 700 are considered good. If your score falls below the 700 mark, you may want to take steps to increase your credit score. One way to do that is by taking out a personal loan.
A personal loan is an unsecured installment loan that is based solely on your creditworthiness, past payment history, and income. Due to its availability, flexibility, and lack of collateral, a personal loan could be an accessible tool to consumers looking to boost their credit. Here’s why.
How Would a Personal Loan Build Credit?
It might sound counterintuitive to take out a loan to make your credit score higher, but taking out the loan isn’t what will raise your score. Paying the loan back should boost your credit score.
Creditors will see previous installment loans in your report. If you have an installment loan in your credit history that was handled appropriately or even paid off early, it may send a signal that you’re financially responsible and can be trusted to pay your debts.
As mentioned, personal loans offer advantages compared to other loans. They are very flexible with amounts starting at $1,000, allowing you to take out a smaller, manageable loan with lower monthly payments. Personal loans can be used for everything from debt consolidation to medical expenses, and even for weddings! If you need to take out a larger loan, you still have flexible repayment terms (1-7 years) to choose from. Choosing a longer term can result in a more affordable monthly payment.
Additionally, personal loans are typically unsecured which removes an obstacle if you lack collateral.
Once you’re approved, make your payments on time. Do not be late with your payments. Once paid off, you’ll have another positive accomplishment on your credit report—with the increased score to show for it.
Don’t just choose any personal loan. Make sure to do a meaningful amount of shopping and compare rates and terms before applying. You can start with popular brands like Peerform, but you can also compare traditional banks where you may have your checking and savings accounts. Depending on your credit score and income, different lenders may be able to offer different rates and terms.
There are also a wide variety of online lenders and personal loan companies that may offer competitive pricing and terms even if you have fair or poor credit.
Can A Personal Loan Damage Your Credit?
Taking out a personal loan doesn’t come with a guaranteed score increase. In fact, your score could be negatively impacted if you’re late on payments or default on the loan.
High-interest rates could be a problem for some individuals; personal loan rates can range up to 36% – above the penalty APR on a credit card. If you are applying with low credit, then you may receive a personal loan with a higher interest rate than if you are applying with strong credit. A high-interest rate may contribute to larger monthly payments. If you can’t afford your monthly payments; missing several payments would hurt your credit.
In addition, taking out a loan with high monthly payments could increase your debt-to-income ratio. Having low income and high debt, or a high debt-to-income ratio is a negative credit score factor.
Alternatives to Consider
If all this sounds a bit risky, that’s okay—you have other options as well. If you have other debt, you could re-focus on paying off other credit accounts like car loans, student loans, or credit cards. All of those affect your credit significantly as well and paying them off can only help.
You could also get a new credit card and use that to build your credit. You can build credit by making one or two small purchases each month and paying off the bill. If you choose this option, shop around for a card that offers rewards you can use, cash back, or comes with an introductory APR to save more money.
If you need to build your credit, it’s not difficult. It does, however, require a bit of work and time; your credit score probably didn’t drop overnight, and so it can’t be massively increased overnight either. Before choosing any personal loan, take a hard look at your finances and understand what you can afford. If you can’t get the right deal in the personal loan market, look at some of the alternatives you have available.
Andrew Rombach is a Content Associate for Lendedu – a website that helps consumers and small business owners with their finances. When he’s not working, you can find Andrew hiking, hanging with his cat Colby, or edge guarding in Super Smash Bros.