All the time, we hear about how important it is to pay off debt to improve credit. While this is true, there are times when personal loans can give you a push in the right direction. However, the credit benefit lies in how well you handle the loan.

The Lowdown on Personal Loans

A personal loan is acquired at a bank or other financial institution and is issued for a fixed period of time. On-time monthly payments until the loan is paid off will reflect positively on your credit report.

If you’re thinking, “But I can just get a credit card if I want to improve my credit,” a credit card is called a “revolving line of credit.” The payment amounts vary based on the amount of your balance. This is why personal loans tend to hold more weight with credit bureaus than credit cards when it comes to positive payment histories. Plus, having a personal loan diversifies your credit profile, which can give your credit rating a boost.

Although credit cards give flexibility and convenience, the interest rate is always higher, which makes the debt more expensive. This is why it is recommended to not have too many credit cards in your wallet.

Too many credit cards is why some people will acquire personal loans. They use the funds to pay off or pay down expensive debt. This can be very helpful in reaching your financial goals.

Nonetheless, it’s important for you to know how to use a personal loan to get that financial and credit score boost you’re looking for.

  1. Find the best loan rate

Do your research to find the best possible rate and terms. When you do your own comparison, you can narrow down your lender options that meet your specific needs. The lowest rate is ideal because it makes the debt cheaper, thus it’s easier to pay off.

2. Don’t submit too many applications

One reason why you want to narrow it down is because you don’t want to apply to every loan you find. Too many credit inquiries can hurt your credit score rather than help it. Apply with just one or two lenders so the inquiries, which can stay on your report for approximately 2 years each, are limited.

3. Read the Loan Terms Carefully

Yes, it can be difficult to read the small print, but you have to. You need to understand the origination fee, interest rates, APR, hidden fees, and penalties. This will keep you from being surprised later on.

4. Don’t borrow more than you need

Only borrow the amount of money that you need. It can be tempting to borrow more so you have additional cash in your pocket but borrowing too much can put a strain on your budget later. If you’re strained, you could miss payments and hurt your credit. Establishing an on-time payment history means not overextending yourself financially.

5. Use your personal loan wisely

There are different ways that you can use a personal loan. One of those ways is to consolidate debt by using the loan money to pay off other debt. This reduces the number of payments you have each month, as well as the amount of interest that you must pay on other debts. Your credit utilization ratio is also reduced, which reflects positively on your credit report. It’s recommended that you not use more than 30% of each credit account’s limit. In other words, you don’t want to use more than 30% of your credit accounts combined.

6. Don’t make a single late payment

A single late payment can have a devastating impact. It is much harder to make up for one late payment than it is to try and make that payment on time. At the same time, on-time payments improve your credit score. Make sure when applying for a loan that the institution reports to all major credit reporting agencies. This is so all on-time payments are reflected with all of them. Nothing is more frustrating than having a loan that only reports to one or two agencies when you need it to report to all of them.

7. Avoid growing your debt

If you use your personal loan to pay off debt, avoid opening new accounts. Doing so can defeat the purpose of the loan. Paying off debt with a personal loan and then opening up new accounts simply gives you a new loan to pay on with not much benefit outside of the on-time payments. Score boosters like score utilization and even a low debt-to-income ratio can go out the window if you continue to pile on the credit accounts. In other words, you need to resist any offers you get through the mail.

8. Keep track of how you’re doing

You need to keep an eye on your credit as you build it so you know how you’re doing and what your next move needs to be. It is good to use a credit monitoring service, particularly a free one so that you can keep track of what is reflected in your report. If you see something that doesn’t belong in your report or information is inaccurately reported, you can use these services to dispute those items.