Can a personal loan help you have a good credit profile?
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While the goal everyone should strive for is to become debt free, there are circumstances where life throws you curveballs and you find yourself in need of financial assistance.
An emergency fund is the best line of defense to protect you from these unexpected expenses.
However, especially early in one’s career, an emergency fund may not be adequately funded or perhaps the financial hit overwhelms whatever reserves you did create.
At this point many turn to credit cards to float them the money needed, however the interest rates from credit cards can be quite exorbitant.
Even lower on the totem pole are predatory lending businesses that can make the debt incurred insurmountable.
One option to consider is the personal loan.
Good Nelly, from My Way Of Viewing, has several prior contributions as a guest poster on this website.
Her latest submission addresses the topic of personal loans and some of the benefits of this method versus others at your disposal.
[Disclaimer: We have no financial relationship.]
Imagine this scenario:
You are hit with an unexpected financial emergency and are now in desperate need of immediate cash.
You perhaps can turn to credit cards to bail you out, but are there any other preferable options?
One option to consider is a personal loan.
Personal loan – What is it and what different types are there?
A personal loan is a loan that you can take out from a financial organization for any purpose.
The funds received can help you pay back your sudden medical bills or a personal business expense.
There are 2 types of personal loans: Secured and Unsecured loans.
Unsecured Personal Loan:
- The benefit of an unsecured loan is there is no collateral required.
- Because the debt is unsecured, the lender will demand higher interest rates to compensate for the increased risk of lending this money.
Secured Personal Loan:
- Interest rates are much lower compared to unsecured loans.
- Collateral is required which can subsequently be lost if the terms of the loan agreement are not fulfilled.
With either a secured or unsecured personal loan, you are expected to make regular monthly payments to repay the loan within a stipulated period.
If you take out a fixed-rate personal loan, the monthly payments will be the same over the loan tenure.
Why not just use a credit card?
A personal loan is usually of much lower interest than a credit card.
On top of that benefit, there is potential to improve your credit profile even more than if you resorted to only using credit cards.
How a personal loan can actually help you improve your credit profile.
A personal loan can help to build your credit record.
It can enhance your credit mix and help you improve your credit profile.
The credit mix constitutes about 20% of your credit score.
The rationale for this component of the credit score is that it shows that you are capable of managing different types of loans/debt efficiently.
Making timely payments on any installment loan, which includes personal loans, creates a positive credit history.
Obviously care must be taken to avoid late payments showing up on your credit report which can drastically lower your credit score.
Other advantages of obtaining a personal loan.
You can take out a personal loan to repay multiple higher interest loans, thereby substituting multiple loan payments with a single one every month, which is far more convenient.
If you can’t repay your credit card debts in full, you can negotiate with your creditors to reduce the payoff amounts (be aware that getting a settlement for a lower amount can reduce your credit score).
A personal loan can then be obtained to make lump sum payments on your credit card balance.
By getting rid of these debts, you have a chance to start fresh with your finances.
A personal loan can also lower your credit utilization ratio.
Your credit utilization ratio is an important factor in your credit score calculation; the lower the better.
A personal loan doesn’t affect your utilization ratio since it’s an installment loan.
Things to consider before getting a personal loan.
It is wise to first shop around the various personal loans available and compare terms and conditions before you sign on the dotted line.
Be aware that having hard inquiries on your credit history while shopping around can have a small negative impact on your score.
However if all the inquires are done within a period of 45 days, it will only count as a single hard inquiry which lessens this impact.
Consider the interest rate and fees before taking out any loan.
Consider other terms and conditions like origination fees and prepayment penalties, if any.
The origination fee is often unavoidable as the lender is trying to recoup the cost of processing the loan.
It is also important to be aware of any potential prepayment penalties that may exist in the wording of the loan.
A lender often has a clause that allows for a financial penalty to be incurred if you pay back the loan before a certain time frame.
Hopefully, by using a personal loan as a temporary bridge to cross over a difficult financial period, you come out on the other side unscathed and ready to build up your net worth.
If you are in search of financial help, please consider enlisting the service of any of the sponsors of this blog who I feel are part of the “good guys and gals of finance.”
Even a steadfast DIY’er can sometimes gain benefit from the occasional professional input.
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