It’s hard to overstate the importance of good credit. Whether you’re a college student, a working professional, a parent or a widower, building and maintaining good credit is vital. Big life decisions, such as buying a house, a car, leasing an apartment, or even getting a job, could depend on your good credit history. While there are many factors that affect your credit score, obtaining a personal loan can help you build or repair your credit. Here is how it works.
How Is Your Score Calculated?
Your credit score is based on your credit report, which is a detailed list of information provided by lenders and service providers that have extended you credit.
Although there are several types of credit scores, the scores most lenders use, such as FICO scores and VantageScore, are based on five variables:
1. How good you have been at paying your bills and loans in the past.
2. How much debt you have now.
3. The length of your credit history.
4. How many new lines of credit you’ve opened recently.
5. The types of credit on your credit history.
Applying for a personal loan can help you improve your credit score.
However, before you can improve your credit score you need to know how bad it is. You can check your credit report for free at annualcreditreport.com, but that will not give you your credit score. If you’re on a budget, you can get a FICO score from one of the national credit bureaus (there are three) for as little as $1, if you sign up for a week trial. However, they can get expensive quick if you forget to cancel the trial. Checking your FICO score with all three credit bureaus will cost a $20 to $40, but is a good idea, if you can afford it. Websites like Credit Sesame do a great job of summarising the key factors of your credit report and gives you a free credit score.
One of the most important factors in a credit score is how reliable you have been at paying past credit accounts. It accounts for around 35% of your credit score. By getting a personal loan and faithfully making all the payments, you show you are reliable and capable of meeting your financial obligations.
The problem is that if you have made bad financial choices in the past and your credit is poor, most lenders will not want to give you a second chance. Personal loans lenders are usually more flexible when it comes to credit eligibility than other credit providers, such as mortgage lenders and credit card providers. If you make regular payments on your loan, and your lender reports those payments to the credit bureaus, it could help rebuild your credit.
Length of Credit History
Even if your credit history does not include any black marks, such as a bankruptcy or late payments, your credit will still be poor if you don’t have a long credit history. The length of your credit story determines 15% of your credit score.
Lenders are more likely to approve customers with an established credit history. Personal loans usually have terms ranging from 1 to 5 years. A personal loan paid in full with no late or delinquent payments will get your credit history started and could go a long way toward rebuilding your credit score.
Types of Credit History
Lenders prefer clients with a wide variety of credit accounts. Even if you’ve never missed a credit card payment and your credit to debt ratio is excellent, a bank may get nervous if they only see credit card accounts on your history and no record of an installment loan.
Each type of credit account has its own characteristics. Lenders prefer customers who have already successfully paid similar credit accounts. The credit mix in your credit report will account for up to 10% of your credit score.
The bottom line is that a personal loan can help you build or improve your credit by creating a positive record on your history. This will contribute to reassure future lenders of your reliability as a borrower. Personal loans from major lenders, such as LendingClub and SoFi, can have strict underwriting guidelines. There are other players that also report to the bureaus and have less stringent underwriting requirements. Apply for a personal loan with lenders that consider borrowers with poor credit who report payments to credit bureaus, such as NetCredit. These lenders don’t have the lowest interest rates, but they are often willing to overlook previous financial mistakes and give you the opportunity of rebuilding your credit history.
Audrey Henderson is a Chicagoland-based writer and researcher. She holds advanced degrees in sociology and law from Northwestern University. Her writing specialties are sustainable development in the built environment, policy related to arts and popular culture, socially and ecologically responsible travel, civic tech and personal finance.