How a Personal Loan Can Boost Your Credit Score
Having a good credit score is one of the most essential steps to financial success. With a good credit score, you can get better rates on your mortgage, you can find better places to rent, and you’ll save thousands of dollars in interest on future loans.
Many people understand the importance of establishing a good credit score but are not sure how to start building their credit. Below are a few important factors that can impact credit score, tips on how to manage your score, and reasons why securing a personal loan can be a great way to improve those key inputs to building your credit.
The Age of Your Credit History
Future lenders and creditors will evaluate a person’s credit history to see if he or she has a track record of paying loans back on schedule. The longer your track record of paying back loans, the less of a risk for payment you will be to future lenders. Since the age of your credit history is a factor in your credit score, it is important to start building your credit early. If you don’t have much of a credit history yet, a personal loan is a great way to start developing one. As long as you make your payments on time, you should see your credit score start to rise.
Your Credit Utilization Ratio
One of the most damaging factors to your credit score is a large debt-to-credit ratio, also called your credit utilization rate. This ratio is simple: how much do you currently owe, divided by the total credit available to you. Credit cards offer a good example: if you have a monthly limit of $10,000, and typically carry a balance of $9,000 on your card in a month, your utilization ratio would be 90%.
A large debt-to-credit ratio indicates to future lenders that you routinely use too much of your available credit. According to myFICO, the group with the highest credit scores uses only 7% of their available credit on average. So if you’re stuck using 50%, 75% or even 99% of your available credit monthly, your credit score will likely take a hit. A lower credit score can make new borrowing even more expensive.
Consolidating credit card debt through a new personal loan can be one of the best ways to improve your utilization rate, because you’ll have additional credit in the form of the new personal loan. Of course, you’ll need to avoid charging up balances on your credit cards again. A lower utilization ratio can lead to an improved credit score. On top of that, because a personal loan is an installment loan (meaning that it is repaid over time with a set number of scheduled payments), a structured payback timeframe can help some people stick to paying back the loan more quickly, thereby lowering your future utilization ratio.
Since most credit cards usually have very high interest rates, your monthly obligations under a personal loan will typically be lower than carrying the balance on your card. If you can lower the rates you’re paying, you’ll pay less interest over the life of the loan, too.
Adding Different Types of Credit
An additional factor that can impact your credit rating is your mix of different types of credit, such as credit cards, student loans and mortgages. In general, your credit rating will benefit from a healthy mix of different kinds of debt on your credit report. You want both revolving debt (like credit cards or lines of credit), as well as installment debt like a personal loan. If you currently only have credit cards, adding a personal loan to your credit mix can go a long way in establishing multiple types of credit and boosting your credit score.
Personal loans have many obvious direct benefits – access to cash, predictable payments, lowering interest rates – but their secondary impact on your credit score can be meaningful for your borrowing future. If you find a personal loan that works for you and you believe that you can make your payments on time, getting a personal loan can help you improve your credit score and your financial future. For more information on how to budget for a personal loan, take a look at our personal loan calculator.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a credit repair organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website on credit.
To learn more about how a personal loan can help improve your financial situation, check your own rate for a SoFi Personal Loan.