Everything you Need to Know About Personal Loans and How They Can Raise Credit Scores
If you’re in the process of rebuilding your credit, have you considered a small personal loan? Yes, you would be adding more debt to your original balance. However, you will also be building up your positive payment history. This article will go over what personal loans are. It will also touch on how it can help you build your credit history, along with possible alternatives.
What is a Personal Loan?
A personal loan is a loan typically between $1,000 and around $100,000. This loan is unsecured and comes in both fixed and variable interest rates. An unsecured loan means you don’t have to put any collateral down. For example, a mortgage is a secured loan, with your home as collateral. If you default on the loan, you lose your home.
How Can a Personal Loan Improve Your Credit Score?
The primary component lenders look for is credit card utilization. This is the ratio of your credit limit compared to how much you spend each month. If this is too high, lenders are less likely to work with you because you’re seen as a risk. Credit utilization is reported monthly to the credit card bureaus. A personal loan will improve this ratio, and raise your score. You can also replace your credit card debt with personal loan debt. You would do this to lower the interest rate, and to add installment accounts to your credit history. These accounts give your credit history diversity, and this looks good to lenders.
What Determines Your Loan Interest Rate?
The interest rate on your unsecured personal loan will be greater than a secured loan. This is because the lender is taking a risk, and has nothing to take if you default on it. The good news is that interest rates on personal loans are still lower than most credit cards. This means you won’t be paying as much debt back in interest fees. If your credit is decent, you may be able to lower your interest rate. Your credit history and your debt-to-credit ratio will also play a factor in the interest rate.
When Does it Make Sense to Use a Personal Loan?
If you plan to repay a debt within a five year period, it makes sense to use a personal loan. You have more freedom with how you spend this loan, and this allows more overall flexibility.
Dental or Medical Expenses.
If you have unexpected dental or medical expenses, you know how quickly these can add up. You will usually be able to get a higher loan amount than on a credit card. This means you’ll be able to pay more of the bill up front. The interest rate is usually lower, so this means you’ll pay back less over time. There are special lines of credit for medical expenses.
Emergency Home Improvements.
If you own your own home, you realize that certain emergency improvements can happen. If you can’t get a home equity loan or refinance your mortgage, look into personal loans. A personal loan is a good choice if the improvement will boost your home’s value. You should also consider if the cost of the loan were lower than the increase of your home’s value from the repair. If it is, a personal loan is a good choice.
Significant Life Events.
A personal loan works well for things like wedding expenses. If you’re not willing to have a smaller ceremony to fit your budget, personal loans can help. You should always weight if what you’re buying is a want or need, however. If you have to take out a loan to cover your expenses, plan to repay it within the loan’s limit. If you don’t do this, you’ll be stuck with more debt.
Merging or Consolidating Your Debt.
This is one of the most popular personal finance tips and reasons that people take out personal loans. You can pay off any high-interest debt with this lower interest loan. This means you pay less over the life of the credit card debt by consolidating. If you have multiple payments, you can combine them into one manageable, monthly payment. Merging your debt together works very well for higher interest credit card debt. However, this is assuming that you will pay more than the minimum payments to pay the debt off faster. You could potentially cut your credit card interest by as much as 50 percent. There is also a shorter repayment term, and this will get you in the habit of repaying debts faster.
What Are a Few Alternative Options to a Personal Loan?
If you’re still not sure about taking out a personal loan, there are options available. The first option is a home equity loan. You can use this secured loan if you own your own home. The downside is that your house will act as collateral. This means if you don’t repay the loan, you have a chance of losing your home. If you have bad credit you can try a credit builder loan.
The second option is using balance transfer on a credit card to pay down your debt. You have to have excellent or strong credit to qualify for a 0 percent interest balance transfer credit card. Balance transfer cards are only a good option if you’re planning to pay off the debt within 12 months or less. Twelve months is usually the period for the 0 percent balance transfer card before it changes. A good example of a zero percent balance transfer card is Chase Slate. This card offers a 21 month 0 percent balance transfer fee. It is an excellent alternative to a personal loan as long as your debt is paid off within 21 months.
This article has gone over the concept of personal loans. We talked about why a personal loan is a good alternative in some situations. Also, we talked about the loan interest rates, as well as what determines this rate. We touched on using balance transfer cards instead of a personal loan as well. If you’re thinking about a personal loan, use this article as a guide. It will help you decide if a personal loan is a right option for you.
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