When working to build your credit, there are some well-known best practices and “standard operating procedures” that you have probably read about frequently: Get copies of your credit reports and review them for errors, work with debt collectors, pay down debt, check your credit score regularly for changes (which you can do for free using Credit.com’s Credit Report Card), and so on.
But there is one credit tool that many people forget about, maybe because it seems counter-intuitive when you first hear about it: a personal loan.
A personal loan can be a secured, or unsecured, loan borrowed from your bank, or other types of lenders. This kind of loan can be beneficial to your credit situation, which will ultimately lead to a higher credit score. Here are three ways that it can help your credit:
- Consolidation: A personal loan consolidates multiple debts into one debt, which may mean lower monthly payments and a reduced risk of multiple delinquencies appearing on your credit report. Although you should pay your bills each month, it’s far better to miss a month on one loan than to miss a month on several credit cards and other bills.
- Lower interest: Compared to a credit card, a personal loan can usually be borrowed at much lower interest – sometimes as little as a quarter of the interest that a credit card may charge! Therefore you’ll be able to put more money toward the principle amount rather than paying off high interest charges.
- Additional credit reported: Your credit report will benefit, as it shows your paid-off credit cards and your responsible and regular servicing of your one personal loan.
Personal loans are very powerful tools to help you build your credit, but they’re often overlooked because we don’t usually think of “borrowing” our way out of debt. Here are some tips to help you use a personal loan to positively influence your credit:
- Avoid the “new money” temptation of treating yourself to a new pair of shoes and an evening on the town. Think of this loan as a credit tool, not as a new spending opportunity.
- Consolidate as many of your outstanding debts as possible. Try to get as much debt as you can paid off by this one loan.
- If you have more debt than your loan will pay off, start with any debt that is with a debt collector, then pay off your highest interest debt (usually your credit cards), then pay off your lower interest debt.
- You should see your monthly payments reduced (because of the lower interest rate), but continue to pay as much as you can to pay down your loan.
Bonus tip: If your bank is reluctant to lend you money because of your debt-to-income ratio, and if you own your own home, a home equity loan could be an option for you. A home equity loan is borrowed against the equity in your house. You can often get more money at a lower interest rate (compared to a personal loan), making it an even better way to pay down your debt when you use it responsibly.