You may need a personal loan to pay off medical bills, plan a wedding, or take a family vacation. But what else? Applying for a personal loan can also help you improve your credit or CIBIL score. Credit score or CIBIL score is based on your credit history, and having a good score can ensure that you can avail of credit as and when the need arises.
People often use repayment of credit on credit cards to improve their credit scores. However, credit cards pose the risk of disturbing your expenditure patterns if you don’t act wisely. The non-payment of credit card bills has the worst impact on your credit scores. Since credit cards pose such a risky option, people are increasingly choosing personal loans and their repayment to improve their credit scores instead.
Wondering how to increase your credit score with a personal loan? Here’s all you need to know.
1. Establishing Payment History
Credit scores are dependent on your credit history. If you undertake a loan and follow a repayment schedule, chances are you will boost your credit scores. Timely and consistent personal loan repayment indicates to credit bureaus that you are a responsible borrower, and this is reflected in your credit score. In this sense, a personal loan is one of the fastest and most effective ways of boosting your credit score.
2. Repayment of Old Debts
A personal loan can be used to clear off old debts. Sometimes old debts can become unmanageable for various reasons. A new personal loan with an effective modified payment structure can help you revise debt according to your convenience. This can help maintain a positive payment history and ensure that credit scores remain unaffected by old debts.
3. Debt Consolidation
Although it is a simple and long-known financial trick, it remains one of the most effective ones in helping you improve your credit score. A personal loan can be used to pay off a number of high-interest loans and credit dues with a single consolidated EMI (generally at a lower rate). It reduces the risks of managing multiple loans on a monthly basis as well as lowers the overall interest rate. This can help address consistency issues with the repayment of loans and, in turn, positively affect your credit score.
4. Lower Credit Utilisation Ratio
By opting for a personal loan instead of overusing credit cards for large payments, you can help maintain a low credit utilisation ratio. The credit utilisation ratio refers to the proportion of credit used to that available for use. For instance, if a credit limit of Rs. 2 lakhs is available to you and you have used Rs. 50,000, then your credit utilisation is 25%. If you already have a high credit utilisation, a personal loan can be used to lower the same and help improve credit scores in the process.
5. Credit Mix
While calculating your credit score, credit rating agencies also consider the borrower’s efficiency in managing different debt instruments. Your credit mix is the diversified pool of various types of lines of credit you are currently repaying and holds a significant weightage while evaluating your credit score.
Depending upon your affordability, if you introduce a personal loan into your credit mix and make timely repayments, it will positively impact your credit score. A healthy credit mix will indicate your ability to handle different forms of debt responsibly and is the answer to how to increase your credit score.
Loan Practices That Can Affect Your Credit Score
No doubt, applying for personal loans is an effective solution to how to increase credit scores.But certain personal loan practices can also negatively affect your score. Here are some of these-
Too many loans-
Applying for a personal loan can do your credit score more harm than good if you already have too many loans or unpaid credit card bills in your name. In such a case, getting a personal loan, even to achieve a healthy credit mix, might not be a wise decision. It is best to opt for another loan only after you’ve repaid the existing debt.
Too many hard enquiries-
Each time you apply for a new line of credit like a personal loan or a credit card, the lender does a credit check which gets reflected in the credit report as a hard enquiry. While a few instances cannot make much of a difference, too many hard inquiries can reduce your credit score. In case your credit score is already low, you might want to avoid applying for a personal loan to avoid any negative impact.
In short, personal loans can not only help you solve your credit score problems but also simultaneously address issues of multiple loans by consolidating debt. A low-interest loan rate, in particular, can be used to pay off multiple higher-interest debts. Tata Capital offers low-interest Personal loans with flexible tenure and affordable repayment options