How Personal Loan Can Improve Your Credit Score?
If you are reading this article, may be your Credit Score is lower than you would like it to be, and you are looking for an efficient way to boost it up. Before you start your journey to improve the credit rating, it is imperative to understand the key factors involved, such as:
- What is a Personal Loan?
- How exactly can it aid you to build a better Credit Score?
- Are their drawbacks of taking a Personal Loan for building Credit Score?
What is a Personal Loan?
A Personal Loan is essentially an unsecured credit product offered by banks and NBFCs to aid an individual in meeting one or more financial obligations such as –
- Sponsoring a child’s education
- Meeting expenses of a wedding celebration
- Mending or renovating home or office
- Expanding or setting up business operations
- Buying new gadgets or appliances
- Going on a holiday
- Debt Consolidation& much more!
Personal Loans are characterised by their ready availability, quick approval, swift disbursal, and collateral-free nature. However, the absence of collateral increases the risk propensity for the lender, which is why Personal Loans attract high-interest rates, usually ranging from 11 to 25% per annum. That being said, Personal Loans accrue comparatively less interest than Credit Card dues, wherein the interest rates can be as high as 28 to 42% per annum. Hence, a large majority of people opt for Personal Loans in a bid to consolidate their Credit Card debts into an affordable loan product payable at lower EMIs.
In most cases, the lender gauges the ability and willingness of the borrower to repay the loan by assessing their monthly income as well as their Credit Score. The higher the income level and Credit Score, the easier it is for the borrower to get the loan at a competitive interest rate.
While this may seem counter-intuitive since your Credit Score is on the lower end of the spectrum, there are numerous lenders which readily offer Personal Loans to borrowers with a lower score, albeit at a slightly higher interest rate. This little expensive Personal Loan will still do the trick for you. You can apply online to the top NBFCs after a wise comparison at the financial services distribution website.
Importance of Personal Loan for Improving Credit Score
A Personal Loan can help you in more than one ways to improve your Credit Score. Let us explore each of the aspects which can help you on your journey to building a higher Credit Score:
- Lower Credit Utilization Ratio
When you make large payments on your Credit Card, too frequently, it may result in a spike in your Credit Utilisation Ratio. CUR is the ratio of your monthly expenses as compared to your credit limit. To maintain a good score, it is crucial that your credit consumption ratio doesn’t exceed 30% of the limit.
- Good Credit Mix
One of the factors that determine your Credit Score is a good credit mix. Although it counts for only 10% of your score, however, adding a new credit unsecured loan like Personal Loan can stress your credit rating.
- An Established Payment History
When you pay off a loan in a timely and consistent manner, credit bureaus start seeing you as a responsible borrower, and this behaviour reflects positively on your Credit Score. To this end, taking a small Personal Loan, which you pay off efficiently can help you improve your score swiftly.
- Debt Consolidation
Debt consolidation is a simple financial trick, wherein you pay down multiple high-interest loans and credit dues with a single consolidated EMI which is generally charged at a lower rate. Since the new loan accrues comparatively lower interest, it often proves to be a great way of managing your debts. Not only does it save you from managing multiple payments every month, but it also helps you save the overall interest outgo towards your credits. This helps you in becoming consistent with your repayments, thus improving your Credit Score.
Limitations of Personal Loan for Improving Credit Score
- Additional Inquiries
Every time you apply for a loan, your lender will perform a credit check to analyse your creditworthiness. The same holds true when you apply for a Personal Loan. This hard check will count as a loan inquiry. Considering you are already running behind on your credit repayments, this inquiry may lead to a drop in your score.
- Additional Debt
It is understandable that you are taking the loan to consolidate your existing debt, and as a measure to improve your score. However, if you are not financially prepared to pay off your Personal Loan efficiently, it may result in a further drop in your score and increase your overall debt.
- Additional Fee
Unfortunately, every loan comes with its own set of additional charges, which is also the case with Personal Loans. Right from a mandatory processing fee, to prepayment penalty and late fee, the new loan will entail all, thus making it costlier than what you anticipated. If you are already in any kind of financial distress, these additional charges may further add to your burden.
While there is no doubt about the fact that a Personal Loan can help increase your credit score quite efficiently, you must understand that it is still a debt that would need to be paid off in a timely manner. Hence, if possible, you should try to negotiate the terms of your existing debts such that it becomes more manageable for you to repay them. You need to be extremely diligent with your repayments; otherwise you may end up hurting your Credit Score, instead of seeing an improvement.
Also Read: How Strong is Your Credit Score?
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