Conventional knowledge tells you that your debts have a negative correlation with your credit score. However, that’s not true if you know how to manage your debt. Credit cards and personal lines of credit can be smartly used to improve your credit score. If you make timely and full payments on your cards, you can improve your score quickly.
But, what happens if you have maxed out most of your cards? The bank will promptly put you in their high-risk list. They will also apply higher rates of interest on your borrowings and may exclude you from exclusive privileges that you may have been eligible for, otherwise.
Taking a secured loan is not a practical solution always. Although a secured loan usually offers more favourable terms, you risk losing your pledged asset if you fail to pay off your debt.
How Personal Loans Can Help
A personal loan is usually an unsecured loan that can be paid off in fixed monthly instalments. As your monthly dues are fixed, you won’t run up as much debt as you would on a credit card or other forms of revolving loans.
A personal loan can be used as per your discretion. No lender will ask you to ascribe a purpose to your personal loan. You can use a personal loan to consolidate all your other debts. Available at lower rates of interest, these loans are better alternatives to pay off your card and other debts.
However, you’ll have to make sure that you don’t run up fresh balance on the cards you’re trying to pay off.
Effect of Personal Loans on Your Credit Score
To understand how personal loans can help you, you need to know the factors that affect your credit score. The following factors are some of the important ones that determine the credit score that’s assigned to you:
Your payment history
The number of credit lines
The aggregate debt you owe
Your credit mix or types of credits
The length of each credit
Using a personal loan responsibly, you can positively affect the second, third and fourth factors on the list. A debt consolidation loan can combine all your debts, thereby reducing the number of credit lines. Structured monthly instalments and lower interests can make repayments easier. A personal loan can diversify your credit portfolio, another important contributor to your score.
Negative Correlation Between Personal Loan and Credit Score
While properly managing your personal loan payments can improve your credit score, there are quite a few risks, too. They are as follows:
Every time you apply for a loan, you lower your credit score a little. That means, the number of loans you have applied for will negatively affect your score.
The number of loan rejections can also lower your score. When applying for a loan, don’t go around making applications randomly without checking the eligibility criteria and considering your financial position.
Defaulting on your loan is a warning signal that surfaces on the radar of every creditor. Hence, a loan can get you further enmeshed in a debt trap if you don’t make timely payments.
In Singapore, you can get a line of credit that is four times your monthly salary if your annual salary is between S$30,000 and S$120,000. It can go up to 10 times your monthly salary if your yearly income is more than that. While a high credit limit has its own benefits, it is also riskier. For every default, you can end up accumulating more debt.
Personal Loans as a Means of Debt Consolidation
While consolidating your debts won’t take the burden off you completely, it can improve your credit score nonetheless. Just make sure that the rate of interest is lower on the new loan. You’ll have to deal with just one loan instead of juggling multiple loans. A single lender can also provide a better deal if you’re not in a position to pay off the entire debt.
It is a known fact that every single loan settled can improve your credit score a little. So, even if you can make partial payments to settle the loan, it will help your credit profile.
Ideal Situations for Using a Personal Loan
A personal loan is ideal for your short-term needs. Taking a personal loan may not improve your credit score if you’re not making timely payments on your loans. However, if you have maxed out your cards or have a high debt burden ratio, a personal loan can improve situations remarkably. Make sure that you’re not putting new charges on your card or defaulting on your debt repayments.