All things being equal, most of us would prefer not to carry debt. But there are times when it may be unavoidable. When that happens, you want to make sure you try to pick the best way to borrow. Sometimes that may be a low rate credit card, but at other times a personal loan make sense.
Here are three smart ways to use a personal loan.
1. To Save Money
If you qualify for a personal loan at a lower interest rate than what you are currently paying, you can save money. For example, let’s say you have a $5,000 credit card balance at 21.99%. If you can refinance with a personal loan at 12%, you will save about $500 the first year alone. If it takes you three years to pay off that debt, you’ve saved about $1,500.
2. To Get Out of Debt
Have you ever charged something on a credit card with the intention of paying it off right away, but then found yourself still carrying the balance months later? With credit cards, it’s easy to fall into the minimum payment trap, and drag out your debt for years. By contrast, many personal loans are installment loans, which means they carry a fixed repayment period of two to five years. As long as you can make those payments each month, you’ll know exactly when you will be out of debt. Of course, to make this strategy work, you’ll want to put those credit cards away so you aren’t tempted to run up new credit card balances.
3. To Boost Your Credit
While there are no guarantees, it’s possible to build better credit with a personal loan. There are two ways this can work. One way it can help is with your mix of credit. Most credit scores evaluate your “account mix.” For this factor, the model looks at the different types of credit accounts you have such as revolving and installment accounts. Revolving accounts are your credit cards while installment accounts include personal loans, as well as auto, mortgage or student loans. If you don’t have any installment loans reported on your credit reports, a personal loan may help with this factor.
Another way this factor can help is by reducing a high “debt usage” ratio. For this factor, most credit scoring models will compare your available credit limits on your revolving accounts to your outstanding balances on those accounts. If your balances are more than 20% to 25% of your available credit, then this factor is probably hurting your credit. The best strategy is to pay off your debt, of course, but sometimes that’s impossible. In those situations, you can use a personal loan to pay off credit card debt, and you may see an increase in your credit scores as a result. (The debt usage ratio isn’t a factor with installment loans.)
If you are thinking of getting a personal loan, it’s not a bad idea to first get your free credit report from all three credit bureaus to make sure your information is accurate before you apply. Your credit scores will have a significant impact on the interest rate you get, so it’s also helpful to check your credit scores, which you can do for free on Credit.com. In addition to your free credit score, you will get an overview of what factors are affecting your scores, plus a personalized plan to help you build your credit.
More on Credit Reports and Credit Scores:
- What’s a Good Credit Score?
- How Do I Dispute an Error on My Credit Report?
- How Credit Impacts Your Day-to-Day Life