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Do Personal Loans Affect Your Credit Score
4 Aug 2018

How Do Personal Loans Affect Your Credit Score?

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From housing bubbles to farmer bailouts, we’ve come a long way from the Great Recession of 2008.

But many people are still feeling pressure on their finances, be it from unemployment, underemployment, hefty student loans or some other social-political issue.

The fact is that Americans are in debt. And some may be considering a personal loan to ease the burdens. But is that a winning strategy?

In the following blog, we are going to answer the burning question: do personal loans affect your credit score?

If you’re considering a personal loan to pay off debt and improve your overall credit, you don’t want to miss this information.

How Do Personal Loans Work?

Personal loans are pretty simple.

The process starts with an application. If your request is approved, you receive the agreed-upon amount in a lump sum.

If you accept a loan from a lender, you will have signed a promissory agreement to pay back the loan in agreed-upon installments. These can be monthly or multiple times throughout the month based on loan terms.

Things you should understand before accepting a loan that’s been found for you are:

  • What is the interest rate?
  • What is the payment schedule?
  • What’s the Annual Percentage Rate (APR)?
  • Is there an origination fee? What is it?
  • Is the interest fixed? If not, be prepared to pay more toward the end of the loan
  • Is there a fee for paying the loan off early?
  • How costly is a late payment?

These are all things to consider when deciding whether or not you can finance a loan at all.

Most personal loans are unsecured. That means they aren’t backed by collateral. Collateral is usually an asset that the bank can take possession of if payments aren’t made, like a home or a car.

When choosing a personal loan, you may be given options. But most often those options are unsecured.

Can I Pay Off Credit Cards with a Personal Loan?

A personal loan may be a good option for consolidating credit card debt and securing a lower interest rate. In this way, it can help move your credit score into a positive place.

But how do you know if it’s right for you? Here’s the scoop.

Consider the Terms

The obvious benefit of using a personal loan to pay off credit is getting better terms. Before you take out a personal loan, run through the above questions and decide if the terms make sense to transfer your credit balance.

Examine Why You Are in Debt

If you haven’t taken a really critical look at why you are in debt and how you can get out of it, it’s time to step back from the lending process and do just that.

Evaluate your credit debt and make some important observations about your spending. Were some of those expenditures against your credit limit used for wastefully?

This may be a tough question to think about but can also help you determine outcomes that will keep your credit healthy in the future. Nip bad spending habits in the bud before accepting a loan that is found for you.

How Can I Keep Up My Credit Score?

Personal loans can help people who have a spotty credit history to re-establish creditworthiness. But it takes a degree of discipline.

Here are three things people should focus on when trying to use a personal loan to increase their credit score:

  • Transferring debt can be beneficial for your credit score because installment loans in good standing don’t carry the same weight as maxed out credit cards
  • Taking out a personal loan diversifies your debt, and that can help your credit score
  • A personal loan can offer opportunities to decrease your debt faster, depending on loan terms

Experts say its personal loans can start around $500, and it’s normal for your score to drop at first. Taking out a personal loan means additional reporting to the credit bureau.

But if payments are made in a timely matter, your score will recover quickly.

Here are some strategies for improving your credit score with a personal loan:

Take Out Only What You Need

It may seem like a glamorous option to take a little more than you need to buy a luxury item or start a slush fund, but that’s not good practice for improving your credit score and debt situation.

A personal loan can help you get out of debt, create needed cash flow and improve your financial situation as well as your credit score. But don’t borrow more than you can reasonably pay off.

Having a large personal loan on file can make it hard to move forward in ways like buying a house or getting a car loan. So, make sure to weigh the benefit against the consequences and make a smart decision when it comes to lending.

Credit Score Breakdown

The following items affect your credit score and they each carry different weight.

  • 30% Amount Owed
  • 10% Diversified Credit
  • 15% Credit History: Length of Relationship
  • 10% New Credit
  • 35% Timely Payments

Using the above percentages as a guide, it’s sufficed to say that taking out a new loan can have a negative impact on your credit. But that pales in comparison to the effect that making timely payments can help your credit score, and/or lowering the amount owed.

Cut Your Interest up to 50%

One major motivating factor that’s really positive about loans is the ability to cut your interest down by a lot.

In order to cut your interest down by up to 50% follow these steps to better credit:

  1. Compare interest rates on credit cards with loan offerings that have been found for you
  2. If your credit score is still good, you will have more options
  3. If you can find a rate that significantly lowers your score, consider the payment terms and if you can pay it off in the requested time frame
  4. A shorter loan timeframe can reduce the overall amount paid in interest
  5. You a service like Bonsai, which helps you find favorable loans for your credit score

Using the above steps, you may be able to reduce the amount you pay in interest and reduce some of your monthly financial burdens.

When is A Personal Loan Damaging?

This all probably sounds great. Who doesn’t want to reduce their overall debt burden with a lower interest rate, and a better payment schedule?

But if it sounds too good to be true, consider how a personal loan can damage your credit.

Damage occurs when payments aren’t made on time. Referencing the above percentages, not keeping up with payments can have a big impact on the overall picture of your credit.

Never take a personal loan if you don’t think you can reasonably make timely payments.

Preparing to Take Out a Personal Loan?

If you’ve gotten this far, and you’re still considering a personal loan here’s a few tips to take to the bank:

  • Have goals: set repayment goals, and make sure you stick to them if you are going to improve your credit score. Don’t get pressured into lending that doesn’t meet your needs
  • Calculate the right loan amount: earlier we discussed that people considering loans should be cautious of taking out too much money, it can damage your credit score if you don’t calculate carefully
  • Plan for repayment: during the lending process, repayment should stay top of mind, make a plan to pay it back in full

Do Personal Loans Affect Your Credit Score?

We set out to answer the question: do personal loans affect your credit score? And the short answer is yes.

Personal loans are an excellent vessel to move the needle on your credit score in a positive direction.

But they can also damage your credit score if used irresponsibly or if they fall out of good standing with the lender. For this reason, taking out a personal loan is a major life decision.

When paid on time, personal loans have many benefits for people who may not have had the best experience with credit cards.

At best, they offer lower interest rates, an opportunity for you to reduce your debt and pay it off faster. But if you aren’t absolutely sure you can swing the payment terms on your current budget, you should never accept a loan that is found for you.

Bonsai Finance helps you find personal loans. We find you favorable rates and preferred loans. If you think a loan may be the best option for debt consolidation, contact us today.