How a Personal Loan Can Help Raise Your Credit Score

Improving your credit score by taking on more debt can seem counterintuitive. However, when used responsibly, a personal loan can be an effective way to demonstrate creditworthiness, allowing borrowers to prove their ability to make timely repayments in full.

A personal loan is a line of credit typically repaid in fixed monthly installments over a set period of time. Personal loans are commonly forms of unsecured debt, meaning they’re not backed by collateral, as is the case with a mortgage or auto loan.

A personal loan can help build one’s credit score if the borrower makes timely payments in full. Doing so allows lenders to submit positive reports to the top three credit bureaus, which reflects well on a borrower’s credit report. In turn, this can also boost the person’s credit score, as payment history accounts for 35% of FICO’s calculation.

Personal loans can also improve a borrower’s credit score by diversifying their credit portfolio. While having more debt may seem like a red flag, it can also benefit a consumer by expanding their credit mix, which accounts for 10% of your FICO score. However, the benefit of a diverse credit mix entirely depends on how the debt is managed. Having a variety of credit types that are consistently paid each month can improve one’s standing with creditors.

A consumer’s credit score can also be improved when taking out a personal loan to tackle high-interest debt. For example, if the loan is used to consolidate or refinance credit card debt, the outcome can drastically improve the borrower’s credit utilization ratio, which accounts for 30% of your FICO score. A credit utilization ratio is the percentage of a consumer’s total credit balance measured against their overall credit limit. The lower the ratio, the better it reflects on a consumer’s credit report. While revolving debt (like that of a credit card) contributes to the ratio, installment debt (like that of a personal loan) does not. 

Another potential positive of debt consolidation through a personal loan is how it can make debt easier to manage. Reducing the number of outstanding balances by consolidating into one monthly payment can limit the risk of missed payments. In addition, consumers might be able to obtain lower interest rates through consolidation and refinancing, which helps in paying off debts quicker. 

On one hand, a personal loan is great for spreading out the cost of large expense. More than that, a personal loan can also serve as a financial tool, which can help save money on interest and make debt easier to manage through consolidating and/or refinancing. All of the above can help to improve a person’s score by reducing their credit utilization ratio and enhancing their creditworthiness through timely payments. Once these benefits are understood, it’s just a matter of choosing the right offer for you.