Your credit score or the CIBIL score plays a vital role in ensuring you can avail credit whenever the need arises. If you wish to improve your credit score, taking a personal loan may be a good option. Before understanding the reasons for doing so, it is essential to understand how credit scores work.
Your Credit Score
A credit score is a figure that reflects your credibility. With each credit aka loan, you take or financial transactions you make, there is a record maintained by the credit bureaus. The CIBIL score, measured as a score out of 900 is calculated based on five major factors.
- Credit history
- Total debt owed
- Length of credit period
- Type of loans taken
- New debt
Credit history makes your credibility stronger or weaker according to your punctuality of paying the debt. It represents 35% of the aggregate score. The second major contributor is a total debt owed. If you have more debt owed, your capability to take further credit lowers. This factor contributes 30% of the aggregate score. The length of credit period accounts for 15% of the aggregate total score where the long-term loans are considered as low-risk loans enhancing the score. Your credit mix accounts for 10% of aggregate score describing the versatility of your overall debt. If you have only one type of loan then it is considered risky. Likewise, if you have recently entered into a new debt, this increases your risk. This factor also comprises 10% in aggregate score.
Personal Loan vs. Credit Card
There are unsecured loans where you do not mortgage any assets and take a loan on higher interest rate compared to mortgaged loans. However, personal loans have lower interest rates compared to credit cards. They also provide long-term debt with a large amount and easy installment facility. These two are major contributors to a person’s credit score. Managing your unsecured loans well will give you a decent CIBIL score.
Reasons for taking a personal loan for improving credit score
Credit cards are generally most widely used tools for availing credit. However, personal loans can become a great way to improve your credit score. For utilizing this tool, you need to see the loan agreement carefully and do some analysis so you can shield your credit score from ruining, enhance it to a remarkable extent and save money. Some significant reasons for taking a personal loan for improving credit score are as underneath
High Risk of Credit Cards
Using credit cards may disturb your expenditure pattern if you do not act shrewdly. With such unmanaged expenses, your credit repayment may delay and you may confront credibility issues. Not paying credit bills on time has the worst impact on your credit score. Hence, credit cards are somewhat riskier. If you use a personal loan to repay your credit card bills, you will be able to repay the debt in time and get enough time to repay any expense without spoiling credit score.
Paying off Old Debts
You can pay your old debts with help of a personal loan and clear off old dues that are being unmanageable by you. This helps you in getting rid of old debt and restarting the debt payment with modified terms. A personal loan is a great chance to revise a debt according to your convenience, as the economic condition of a person does not remain same all time. This helps in maintaining a good payment history and avoiding any issues that affect your credit score.
There may be different loans that are due for repayment. It can be troublesome to manage all loans. This gives rise to conflicts and you may forget to pay any due on time. To dispense with this issue, you can use a personal loan and consolidate all your debts. This will give you relief from remembering various dues and eliminate the risk of spoiling your credit score.
Long-Term Payment Option
Personal loans are paid in installments over a long period according to your repayment ability. Subsequently, you do not need to worry about upfront payments. Hence, you can plan for big expenses without spoiling your CIBIL score.
With help of a personal loan, you can manage the repayment schedule. The monthly installment amount should match your repayment ability and it is fixed in advance. Therefore, you can manage your savings accordingly and pay the debt in systematic amounts.
Credit cards have low spending limits and hence you can borrow credit much lesser than what you get on a personal loan. A personal loan allows you to avail much higher credit at easy repayment terms with very low-interest rates.
The overall benefit of personal loans is that they offer a much lower rate of interest than other unsecured loans like credit cards. Low-interest rates are by far the biggest advantage of personal loans. In fact, you can even avail a personal loan to pay the high-interest rate credit card loans. Paying off a high-interest loan and taking a low-interest loan will eliminate your credit risk and improve the CIBIL score.
This factor counts for 10% of your credit score. If you only have credit card debt, then a personal loan will add to your loan portfolio. Diversified credit types are considered less risky compared to the single type of loans.
Easy Credit Trial
Your credit score improves when you take some credit and manage it well over a period. Personal loans are a good way to take an easy trail of credit without having to worry about urgent repayment. You may take a small loan and repay the majority of the amount if not needed getting a reduction on interest. You should not repay the complete amount, keep some debt and improve on your good credit history.
Save Money Over Time
Apart from improving the credit score, you will save money over the long period. Savings on interest rates and systematic loan repayment will save on your interest rates and total interest paid. You will be able to pay off the principal amount easily.
For these reasons, you can opt for a personal loan and manage your credit score. However, you must be careful about the interest rate differences and the terms of the loan. You should also not take loans over limit else, bigger issues will be waiting for you.