The concept of using a debt, like a personal loan, to restore one’s credit may seem perplexing at first. After all, how can going into more debt possibly have any positive effect on one’s credit report? You might be surprised to learn that personal loans are used to restore damaged credit all of the time.
However, this is only true if you have the means to repay the loan as it is expected by the lender. Late payments or, even worse, loans that have gone into default due to non-payment can do some serious harm to a person’s credit. It is only when the individual can repay their debt reliably and responsibly that personal loans may improve their credit situation.
There are two ways that taking out a personal loan – and paying your installments on time and in full – can boost a person’s credit score.
When a person initially receives the loan, it can cause their credit score to dip a few points. However, as monthly payments are made, this effect starts to reverse. Credit reporting agencies like to see that a person can pay their debts on time each month.
When the debt is fully paid and the account with the lender is closed, these agencies look upon this very favorably. By the time this happens, a person’s credit score can receive a surprising boost.
In addition to paying monthly debts on time, credit reporting agencies also like to see that a person knows how to handle numerous kinds of debt responsibly. This is called “diversity” within one’s credit history.
For example, if you have only possessed credit cards with no other lines of credit, this shows very little or no diversity. The inclusion of a responsibly-paid personal loan on one’s credit is an easy way to achieve some diversity. If the borrower can keep on-track with their installation payments, this shows the reporting agencies that they are quite capable of managing more than one form of debt.
Credit Card Consolidation
Some people have found that their credit scores improve after using a personal loan to consolidate their credit card debt. Using a personal loan to pay high-interest credit card debts absolves the debts and compiles numerous lines of credit into one relatively low-interest monthly payment.
Because the credit cards are paid off (in full or in part) and the borrower is making reliable monthly payments on their personal loan, this reflects more positively on one’s credit report. It shows that the individual has repaid several of their outstanding debts and are now being responsible with this new loan.
In short: Good credit practices paired with personal loans can be the exact thing that’s needed to drive a credit score upward.