Guide to using personal loans to improve your credit rating
Maintaining a good or excellent credit score can be hard work, but building one from scratch, or re-building one after missed payments, can be even harder.
There are a number of ways to improve a credit score, with many people recommending clearing credit cards and registering on the electoral roll. However, one of the most effective, yet least talked about methods is with a personal loan.
It seems a little ironic that going into debt can boost a credit score, but the score is simply a number used by the credit reference agencies to represent how reliable a borrower the applicant is.
One of the only ways to establish how reliable someone is, is if they have a repayment history from past credit. For people with colourful repayment histories, a personal loan carries a sense of structure, that credit card debts don’t, and this can be preferable to many lenders.
What is a personal loan?
Unlike a secured loan, which uses assets such as property, as collateral, a personal loan is unsecured.
Personal loans are one of the most popular types of loan on the market, and generally offer between £1,000 and £25,000, over a period of one to five years.
While they can be used for anything, they are commonly used to fund a new a car, home renovations, a wedding, to consolidate debt, or pay for any other high-value purchase.
What is credit mix?
The personal finance market is brimming with a variety of products, from credit cards and prepaid cards, to personal loans and payday loans. However, there are only really two types of credit lines: revolving and instalment.
A revolving account is one where the balance is not due to be paid in full each month, and the monthly payment differs each month depending on the account balance. The most common type of revolving account is a credit card, but others include store cards and overdrafts.
As mentioned credit cards are very popular way of trying to improve a credit rating, as borrowing and repaying the balance immediately can demonstrate the ability to manage credit. However, many bad credit or credit-builder credit cards do not offer the standard 56 days interest free, meaning that cardholders could run up interest charges without realising. In the event that the balance isn’t repaid in full, the high interest fees – usually around 35-40% APR – can add hundreds of pounds to the cost of the debt.
On the other hand, personal loans usually offer a very reasonable interest rate of 4-10% APR. As the monthly payment is fixed, there are no unexpected surprises, and it allows borrowers to budget more effectively, in turn making it less likely that they will miss any repayments.
Converting credit card debt
There are numerous benefits to using personal loans to improve your credit score, but unfortunately, it isn’t always as simple as that.
Personal loans tend to have much stricter eligibility criteria than credit cards, particularly those at the lower end of the market, making it harder for people with low credit scores to be accepted. However, it is worth comparing what is available and speaking to the lenders to discuss your situation. Some banks are happy to lend to account holders if they know the reason they want to take out a personal loan, and are even more likely to if it means they are repaying another debt, such as a credit card.
In the event that you are rejected for a personal loan, or know your chances are limited, it might be worth asking a family member or friend with an excellent credit score, to be a guarantor.
While getting a personal loan might seem like a lot of effort for someone with poor or no credit history, they do look favourable to lenders on a credit report, and can help build trust, in turn boosting your credit rating.
Getting a personal loan
Also, the credit mix means it is important to have both revolving and installment account on file. So, converting hefty credit card bills into easier-to-manage personal loans can boost a credit score before anything has been repaid.
Anyone with substantial balances on their credit cards may be able to save money by consolidating it into a personal loan. Store cards and credit builder credit cards often have extremely high interest rates, making it harder to clear outstanding debts.
There are two main reasons why it is a good idea to convert credit card debt into personal loans: cost and credit mix.
Having a good credit mix, i.e. both revolving and installment credit accounts, is just one way to improve your credit score.
An instalment account also does not have to be paid in full, but rather than the monthly payment varying depending on the balance, it is fixed for a fixed period of time. Personal loans fall under the instalment umbrella, as do mortgages, student loans, and secured loans.