A personal loan is an unsecured loan typically offered by credit unions, banks, and other financial lenders. It can be used for varied purposes like launching a small business, making a big luxury purchase, and debt consolidation, etc. Personal loans generally have an interest rate that is lower than interest rate of credit cards and hence is a better option of credit.
One needs to take into account numerous factors before taking out a personal loan; this includes its impact on your credit score. As per the credit profile of an individual, a personal loan can help improve his/her credit report and credit rating particularly if that loan is used for paying out other debt with high interest rate. Personal loans can also help people in timely payment of bills as it helps decrease the payments outflow every month.
Personal loan is a credit and like all credit accounts, it is vital to repay it every month, without fail, to ensure that your credit is not adversely affected. The main aspect of effective personal loan management is that it impacts your credit only in the positive ways and all negative aspects are avoided. This will ensure that your credit score improves significantly.
A personal loan is a grave responsibility and hence all individuals must do a comprehensive take of the advantages and disadvantages of personal loans on their credit, before taking the step towards applying for a personal loan.
Some of the positive effects of a personal loan on credit are listed below:
- A personal loan can be used for consolidation and repayment of credit card and other high-interest debt. This can help enhance the credit score. It will also ensure that the borrower saves money in the form of interest payment.
- Credit utilization ratio refers to the total revolving debt of an individual as compared to the available/remaining credit. A low credit utilization ratio means a better credit score. Repayment of varied debt via a personal loan can help lower the credit utilization ratio and boost credit.
- Regular and full repayment of the personal loan can help establish a history of timely repayment of the loan. This can enhance the credit score.
- More variety gets added to the credit history via personal loans through the creation of a combination of credit types. This eclectic mix of credit types is favorably viewed by most creditors and lenders.
Some of the negative effects of a personal loan on credit are listed below:
- Personal loans are a new debt that you take on. It can thus increase the overall debt burden. It is therefore vital to take only that amount as a personal loan that is needed to repay high-interest ongoing debt (or other uses) and not in excess of that amount.
- Taking out a personal loan will mean a new credit inquiry. It is a hard credit inquiry and tends to adversely affect the credit score.
- It involves extra costs like origination fees, late payment charges, etc. So, factor in these elements when calculating the amount that needs to be taken out as a personal loan.