While a Personal Loan is an excellent funding source during financial requirements and emergencies, it can also be a great way to improve your credit score. A credit score indicates your financial health and largely influences your loan eligibility at favourable interest rates. If you are wondering how to boost your credit score with a loan, below are potential ways to enhance your credit score using a personal loan.
What is a Credit Score?
Before delving into the details, grasp the fundamentals of a credit score first. It is a 3-digit number ranging from 300 to 900, representing your creditworthiness. Credit bureaus generate this score based on various factors, including your existing credit, repayment history, transaction history, diversity in your credit portfolio, credit age, etc. Usually, a score above 700-750 indicates a consistent credit history, convincing lending institutions to approve your loan applications at lower interest rates.
You can also qualify for a loan with a low credit score, but the interest rates will be higher than regular, like when you borrow a small Personal Loan at a higher interest rate and use it to boost your credit score. Eventually, your credit score will be enough to grab a bigger loan with a lower interest rate.
Improving the Credit Score with a Personal Loan
Letโs explore how to boost your credit score with a Personal Loan:
Diversifies the Credit Mix: There are two types of credit: revolving and instalment. If your credit report primarily consists of credit cards, adding instalment credit as a Personal Loan diversifies your credit mix and boosts your score.
Facilitates Timely Repayment: Flexible repayment terms allow you to make timely payments suitable for your monthly budget. Consistently paying the EMI on time indicates financial reliability and responsibility, improving your payment history and boosting your credit score.
Reduces Your Credit Utilisation: An instant loan from a loan app saves you from using your credit card, thus controlling your Credit Utilisation Rate (CUR). Lower CUR positively impacts your credit score.
Establishes a Positive Credit History: Those new to credit or with limited credit history can use Personal Loans as positive credit references, thus establishing a credit history that will lead to a higher score over time.
Demonstrates Responsible Credit Behaviour: Successfully managing your loan EMIs showcases your capacity to handle credit responsibly. This can be particularly useful for those with past credit issues.
Smart Strategies to Use a Personal Loan to Boost the Credit Score
Now that you know how an instant loan positively impacts your credit rating, here are a few smart strategies to maximise the opportunity benefits:
Check Your Credit Report: Before applying using a loan app, request a copy of your credit report, check it thoroughly, and ensure it is accurate. Identify sectors that need improvement and work accordingly.
Compare and Pick the Right Loan App: Look for a highly-rated loan app with simple eligibility criteria and 100% digital application procedures. Also, ensure the lending institution reports your credit activities to the relevant credit bureau.
Borrow Responsibly: Evaluate your requirements before borrowing and only borrow what you need. Moreover, an EMI calculator can manage EMI payments conveniently and promptly. In any case, avoid over-borrowing, which might lead to financial stress and have a negative impact on your credit rating.
Set Up Automatic EMI Payments: Missing a single payment can significantly damage your credit score. To avoid this, set up automatic payments for your Personal Loan EMIs. This guarantees that payments are made on time each month.
Make Extra Payments: If your finances allow, make extra payments or pay off the loan before the term ends. Reducing the outstanding credit balance positively affects the credit score.
Avoid Applying for Multiple Loans: Each loan application results in a hard inquiry on your credit report, and each hard inquiry lowers your credit score by a few points. Therefore, compare the loan plans and apply for one selectively based on your eligibility and financial requirements.
Monitor the Improvement in Your Credit Score: Check your credit score regularly to monitor any improvement. You may subscribe to a regular credit score checking plan to get regular credit reports and monitor your progress. Some credit monitoring services are also free to help monitor your improvement.
Precautions to Take When Using a Personal Loan to Improve the Credit Score
While a Personal Loan can be an effective strategy to boost the credit score, keep these precautions in mind:
Compare the Interest Rates: The Personal Loan interest rates may vary between loan plans. If you have a low credit score, be ready to pay a higher interest rate than normal. However, it should not be excessively high. Compare interest rates for various loan plans to get the best deal and save money. Loans with a low interest rate will also have easily manageable EMIs that make repayment easier.
Make Timely EMI Payments: Missing even a single EMI repayment significantly impacts your credit score. It projects your poor financial health and increases the lender’s risk. Credit bureaus perceive you as an irresponsible borrower and assign you a low credit score. Therefore, staying financially disciplined and consistently making prompt EMI payments is crucial.
Only Borrow When You Need: Do not take credit score improvement as an excuse to borrow a Personal Loan. Borrowing unnecessarily will only accumulate debt and make repayment more challenging. Loans also come with a higher interest rate if your credit score is low, disturbing your finances significantly. Therefore, you must only take out a loan with a low credit score if you urgently need funds or plan to take out a bigger loan.
Maintain Financial Responsibility: Once you improve your credit score with a Personal Loan, maintain financial responsibility for the long term to retain it. If you return to your old financial habits, your credit score will fall back again, and all your efforts will go to waste.
Conclusion
A Personal Loan can be an effective way to improve your credit score. Therefore, borrowing and using one responsibly can be a wise financial move. It works by diversifying your credit mix, saving your CUR, and allowing you to choose an EMI plan suitable to your repayment capacity. Borrow a loan using a reliable loan app, pay the EMIs consistently, monitor your progress, and make smart choices to improve your credit score with a loan and secure a brighter financial health.
