Ways to Use a Personal Loan to Build Your Credit Score

Personal loans are one the simplest forms of lending that enables a borrower to use the availed funds for any purpose. It is an unsecured loan that a borrower can apply for and get immediate funds even in case of an emergency.

As there is no collateral security attached, it gets disbursed quickly based on the applicant’s monthly income, credit score, and payment history. However, most people overlook the fact that a personal loan can also be used to build their credit score, which further helps them in the future when they have to apply for larger loan amounts.

A borrower having a personal loan can improve his credit history by making regular payments. The data of your payment history is sent to various credit agencies that build your good credit history. Unless you can’t afford a personal loan, the lending does not harm your credit rating.

5 Simple Ways to Improve Your Credit Score with a Personal Loan

There are certain factors associated with a personal loan that positively impact your credit score –

1. Payment track records- Your repayment history is the most decisive factor that indicates your financial capability. If you pay your pending instalments regularly, it builds a positive repayment history that invariably leads to a higher credit score.

2. Credit basket- Your credit score also depends upon your credit basket and how well you manage it. If a borrower has a mix of credit cards, personal loans, auto loans, or student loans within his/her limit, and they pay the instalments regularly, the credit score improves vastly as opposed to just having a single loan.

3. Debt amount- You can use a personal loan to pay off your credit card bills to reduce your credit utilization ratio. A credit utilization ratio is how much you currently owe divided by your credit limit. For example, if the credit balance you can utilize is ₹50,000 with a credit limit of ₹1 lakh, your credit utilization rate is 50%. By taking a personal loan,

you can pay off your credit card bill to bring down the credit utilization ratio thereby increasing your credit score.

4. Debt consolidation- If you have a large debt with multiple EMIs to be paid every month, debt consolidation can help to avoid a situation of being bankrupt and improve your credit score. Suppose you have more than two credit cards with outstanding balances, then you have to make payment at three different interest rates. However, if you take a personal loan and pay off the outstanding balance of three credit cards, you’ll only be repaying a single EMI. It becomes easier to make one instalment a month at a specific interest rate. If the personal loan is available at a lower interest rate, it also allows you to save money. The process of debt consolidation can help in lowering your credit utilization rate which is a key determiner of the credit score.

5. An option of credit builder loan- A unique form of lending is a credit builder loan. It is an intention to build your positive credit report by paying a fixed amount month over month for a specific amount of loan. Here, you don’t get the borrowed money until you pay the full amount plus interest. The ultimate objective is to build a good track record with regular payments to improve your credit history. As soon as the payments are made, the lender sends the information to the credit agencies to update the regularity of payments. As no amount is due, you are entitled to receive the full amount sanctioned. It is very similar to putting money in a savings bank account with an opportunity to improve your credit score. It is not a very popular option among both lenders and borrowers. It also not suitable for every borrower as it requires a fee to open a loan account.

Risks attached with using a Personal Loan to Build Credit Score

Before considering the above options to avail a personal loan, it is necessary to overview your financial health and repayment capacity. It is recommended to study the suitability factors of taking a personal loan to improve your credit report. If this is the right choice for you, it would surely help to enhance your credibility. But in case you go wrong, certain risks can arise –

· Strict inquiry-

When a borrower applies for a personal loan, a strict inquiry is initiated. An inquiry temporarily drops your credit score and it lasts for a few months. It creates an adverse situation if you have

been applying for a loan at different institutions in the recent past. The credit report would show multiple inquiries on your credit report that would end up lowering your credit score.

· Increase in debt-

Even if you are taking a personal loan to improve your credit score, debt is debt. Increasing your debt is not good for your financial health. Before applying, you must consider your repayment capacity and limit.

· Attached Fees-

In a personal loan, you pay the processing fee, prepayment fee, as well as interest on payments. Hence, you are paying more than the amount which is disbursed to you. Hence, you should factor in the total fees attached to the personal loan.