Boosting credit score via personal borrowing tactics
Personal loans can be a valuable tool for improving credit scores, but they come with their own set of pros and cons. Here's what you need to know about using personal loans for credit building.
Benefits of Personal Loans for Credit Building
Personal loans contribute to a credit score primarily by building a positive payment history, improving credit mix, and potentially reducing credit utilization if used to consolidate revolving debt. These factors together can raise your credit score over time with on-time payments [1][3].
- Positive Payment History: Timely monthly payments reported to credit bureaus build a positive repayment history, which accounts for about 35% of the FICO score [3][5].
- Credit Mix: Having different types of credit, such as an installment loan alongside revolving credit, improves the credit mix (about 10% of score) [1][3].
- Credit Utilization: Using a personal loan to pay off credit cards can reduce your credit utilization ratio, another significant factor (around 30% of FICO score) [1][2][3].
Risks and Considerations
While personal loans can help improve your credit score, they also come with potential risks that need to be carefully considered.
- Temporary Score Dip: Taking out a personal loan means adding new debt, which can temporarily lower your credit score. The hard inquiry done when applying typically reduces the score by around 5 points but usually rebounds within a year or two [1][2][3].
- Increased Debt Load: Adding a personal loan to your report can increase your total debt burden, which should be carefully managed to avoid financial strain.
- Fees: Fees like origination, late payment penalties, or returned payments can increase your costs and potentially impact your ability to make on-time payments.
- Negative Impact of Missed Payments: Failure to make payments can hurt your credit score significantly and potentially lead to other financial consequences.
Strategies for Responsible Personal Loan Use
To maximise the benefits of personal loans for credit building, it's essential to use them responsibly. Here are some strategies for effective personal loan management:
- Debt Consolidation: Using a personal loan to consolidate revolving debt can help reduce your credit utilization ratio and make payments more manageable.
- On-Time Payments: Always make on-time payments to build a positive repayment history and maintain a good credit score.
- Buy Now, Pay Later Services: Services that allow you to pay for everyday bills, like streaming services, monthly subscriptions, and utilities, can help improve your credit score if used responsibly.
In summary, personal loans can be a useful tool for credit building if managed responsibly with on-time payments and strategic use (e.g., debt consolidation), but carry risks like a temporary score dip, increased debt load, and fees that need to be weighed carefully [1][3].
[1] MyFICO. (2021). How Personal Loans Affect Your Credit Scores. [online] Available at: https://www.myfico.com/credit-education/whats-in-my-credit-score/personal-loans-and-credit-scores
[2] Experian. (2021). How Personal Loans Affect Your Credit Score. [online] Available at: https://www.experian.co.uk/consumer/guides/credit-scoring/how-personal-loans-affect-your-credit-score.html
[3] TransUnion. (2021). How a Personal Loan Can Improve Your Credit Score. [online] Available at: https://www.transunion.co.uk/credit-education/credit-scoring/how-a-personal-loan-can-improve-your-credit-score
[4] Equifax. (2021). How Personal Loans Affect Your Credit Score. [online] Available at: https://www.equifax.co.uk/learningcentre/credit/credit-scoring/how-personal-loans-affect-your-credit-score/
[5] FICO. (2021). Understanding Your FICO Score. [online] Available at: https://www.myfico.com/credit-education/whats-in-my-fico-score
"Using personal loans strategically, such as debt consolidation, can help improve your personal-finance situation by reducing credit utilization and making payments more manageable, thereby contributing to a better credit score."
"However, it's crucial to be aware of the potential risks associated with personal loans, like a temporary dip in your credit score, increased debt load, and various fees, and manage them responsibly to reap the benefits of credit building."
