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Did you know a Personal Loan can improve your credit score? Read below to understand how your credit score can progress with a personal loan.
When you are trying to improve your credit score, usually credit cards are the first thing that may come to your mind. However, did you know that a personal loan can help you raise the credit score? When managed wisely, a personal loan can be a very useful tool for boosting your credit score. Before we get into how a personal loan can improve your credit score, let’s take a look at what a personal loan is and what all benefits does it offer.
A personal loan is a type of instalment loan, also categorised as unsecured loan that you get from a bank or any other financial institution, or online money lender. Personal loan doesn’t require collateral as in the case of a mortgage and it can be used for almost any purpose from medical expenses to a wedding or home improvements. It can be a handy financial tool to pay off a large, one-time expense or debt. The approval based on your creditworthiness, which includes factors like your credit score, income, and debt-to-income ratio. Even the interest ratee that you can avail the loan at will depend on your creditworthiness. Personal loans are typically repaid in fixed monthly instalments over a predefined period, ranging from a few months to many years.
A personal loan can be used strategically to manage your credit score. You need to ensure timely payments as agreed and manage everything responsibly to use personal loan as a powerful tool to better your credit score. From enhancing your credit mix to building payment history that looks positive, a personal loan offers multiple avenues to increase your creditworthiness. However, the key lies in disciplined repayment and a clear understanding of how it fits into your overall budgeting and financial management. By leveraging a personal loan wisely, you can not only meet your financial needs but also strengthen your credit profile for the future.
There may be additional documents required varying from applicant to applicant.
1. Loan can be used for any purpose: One of the major benefits of a personal loan is its flexibility. Unlike other loans which are availed for specific purposes and have to be spent only for that, personal loans can be used for a whole variety of requirements, almost any purpose – wedding expenses, home repair work, office repairs, etc.
2. No need of indemnity or collateral: Personal loans come under the category of unsecured loans which is why you don’t need to risk any of your assets to obtain the loan. This makes it a relatively safer option for borrowers who may not have any valuable assets in their kitty to pledge.
3. Fixed interest rates: Usually, personal loans are given at fixed interest rates, meaning your monthly EMI remains the same throughout the loan tenure. This certainty helps borrowers to manage and plan their monthly income-expenditure better.
4. Consolidate your debts: Personal loans can be an effective tool for consolidating high-interest debt, such as credit card balances. When you consolidate your debt into one loan with a lower interest rate, you can save on EMI payments while also simplifying your finances.
5. Improve your credit score: A personal loan can also be used as a tool to improve your credit score, provided it’s planned strategically and managed responsibly.
Now that you know what a personal loan is and how it can benefit your CIBIL rating, we can now move on to understanding how it can be a tool to improve your credit score.
1. Building a positive payment history: Do you know that with a personal loan you can build a positive payment history? One of the most important factors in determining your credit score is how good and disciplined your payment history looks. It accounts for a major chunk of your CIBIL score. Availing a personal loan and making timely payments month on month can help build a positive payment history. Each on-time payment adds to your creditworthiness, signalling to lenders that you’re a responsible borrower, which in turn can increase your credit score.
2. Diversifying your credit mix: Credit scoring models, such as CIBIL which is widely used and accepted in India, consider the types of credit accounts you have when calcuating your credit score. A well-balanced credit portfolio that has a mix of credit types, such as credit cards, EMI loans (like home loans or personal loans), etc. can boost your score. If your credit history consists mainly of credit cards, adding a personal loan can enhance your credit mix, potentially leading to a better CIBIL score.
3. Reducing credit utilization: The amount of credit you’re using compared to your credit limit, is another key factor in determining your credit score. A high credit utilization ratio can impact your score adversely. If you use a personal loan to pay off existing credit card debt, you can reduce your credit utilization ratio, potentially raising your credit score. For example, if you pay off your credit cards using a personal loan, your credit utilization rate drops, which may positively influence your credit score.
4. Establishing a longer credit history: Credit history length, including the age of your oldest account, the age of your newest account, and the average age of all your accounts, plays a role in your credit score. If you’re newer to credit, taking out a personal loan can help establish a longer credit history over time. While the impact might not be immediate, consistently managing a personal loan will contribute to a longer, positive credit history.
5. Demonstrating meticulous credit behaviour: Lenders and credit bureaus view responsible credit behaviour favourably. By taking out a personal loan and repaying it according to the agreed terms, you demonstrate your ability to manage debt responsibly. This behaviour is reflected in your credit report and can gradually lead to an improved credit score.
While a personal loan can improve your credit score, it’s essential to approach it with caution. Borrowing more than you can afford to repay or missing payments can have the opposite effect, potentially lowering your credit score. It’s crucial to ensure that the loan terms are manageable within your budget and that you’re committed to making payments on time.
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