Having a bad credit score can be a lot messy. The pressure of the debt you may have fallen into can rob you of a good night’s sleep and daytime peace.
Having a bad credit score can mean a higher interest rate on your credit cards and loans. Also, with a bad credit score, creditors or lenders may see you as a huge risk and to overcome this risk, they will charge you higher rates.
There are quite some techniques that can be employed to improve a bad credit score. However, the question of how to obtain personal loans and its benefit to your credit score keeps popping up in consumers’ minds. But how true is this? You will find out in this piece.
What’s a Personal Loan?
A personal loan, simply put, is an unsecured loan. You don’t need to put up any collateral or make a down payment to receive the loan.
Application for a personal loan can be made through many different financial institutions like banks, credit union, and other online financial companies. The terms and interest rates of personal loans vary from business to business.
Personal loans are simple and straightforward. You apply, receive approval, and then you can receive the money in the sum you requested. The loan is often returned in installments over a time frame which is determined by the terms of your loan.
Now we know how a personal loan works, but how can it improve a bad credit score?
Every debt influences your credit score, personal loans inclusive. It, however, does not mean that obtaining personal loans always have adverse effects on your bad credit situation. In fact, when managed correctly, this type of loan can improve your credit score with time.
Credit scores are affected by five factors, with their approximated quotas highlighted below.
- Credit mix: 10%
- New credit: 10%
- Credit history length: 15%
- Amount owed: 30%
- Payment made: 35%
When you get a personal loan, the factors that would normally disrupt your credit score typically fall under the category of ‘credit history length’ and ‘new credit.’
During your loan application, the inquiry often impacts your credit score and makes it drop by five points (though it’s not as bad as it sounds). However, the most important credit score factor is the ‘payment history’ according to FICO and is contributes about 35% of your total credit score.
After obtaining a personal loan, the factors that affect your credit score most are the payments you make and the credit mix which the loans add to your profile.
Your credit score is positively impacted every time you make a timely loan payment and in full. The more often you make those payments on time, the better your credit score gets.
Credit mix might weigh just 10% of your credit score, but it still contributes positively in the long run while payment history which weighs a huge 35% drags your credit score upwards positively as long as you continue to make full payments on the obtained loan.
Obtaining personal loans can be a great remedy for a bad credit score when the terms are adhered to but can be disastrous if not properly handled.