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At Bamboo, this is a question that we hear a lot: can taking out a personal loan help me repair my credit score? How does that work? Surely saving my money – rather than borrowing some more – is going to be better for my credit score?
So, we thought we’d go into a bit more detail as to how – in a lot of circumstances – taking out a personal loan can help repair credit scores – even if they’re bad or fair. If you’re unsure of your credit score, why not take a quick look over our guide to finding out your credit score for free.
To understand this properly, we need to go into a bit of depth as to how credit scores are calculated:
• 35% of your credit score is based on your repayment history – whether you’ve missed payments, made payments on time, defaulted, had CCJs etc.
• 30% of your credit score is based on your total debt – how many loans you’ve got, how much you have on credit cards, if you’re in your overdraft etc.
• 25% is based on the length of your credit history and any new credit you’ve taken out – how long you’ve had a bank account, how many types of credit you’ve opened in a short period (taking out or applying for lots of credit cards in a short time suggests impending money problems, at least to the computers doing the calculations).
• The final 10% is based on the different types of debt or credit you have – student loan, mortgage, personal loans etc. This is because lenders like to know that you can manage a variety of different accounts in a responsible manner.
As you can see, a personal loan will negatively affect the total debt consideration and the new credit consideration. However, it’s a lot more complicated than that. Taking out a personal loan – as long as you can consistently make the monthly payments on time – can help you repair your credit score as it demonstrates a reliable payment history and a range of different debts.
Use a personal loan to pay off other debt
On top of that, a personal loan can also help you repair your credit score by letting you pay off other debts – especially if you’ve got credit card debt that you’re struggling to keep on top of, or only manage to pay the interest for every month.
By clearing your credit card debt in one go with a personal loan, you lower something called your ‘utilisation rate’. Your utilisation rate refers to how much of your total available credit you’ve used, and anything over 30% of your total available credit can hurt your credit score. The longer you’re over this 30%, the worse it is for your credit rating.
(In real terms, if your credit limit on a credit card is £1,000 – you shouldn’t use over £300 of that. Or, if you do, you should pay it off within a month or two.)
And, because they’re considered different kinds of debt, regular personal loan repayments – even if they’re the same amount as the credit card repayments – are often looked upon more favourably.
However, it is important not to close the credit card once you’ve paid it off. If you do, the available credit and utilisation rate – which are both helpful for your credit rating – are removed from your file, which could harm your credit rating.
Will a personal loan hurt my credit rating?
In the short term, taking out a personal loan could lower your credit rating for a short amount of time. Because you’ve taken on more debt, for a brief period, it’s likely that your credit score will drop.
However, over the course of the loan, this should even out and – as you make regular repayments, your credit score should steadily improve, especially if you’ve also cleared other debt.
Also, it’s very important to note that if you take out a personal loan (whether it is to consolidate other debt or purchase goods) and miss payments, then it’s very likely that you will hurt your credit rating further. That’s why it is important to be sure, before you take out the loan, that you can make all the repayments. Failure to make payments and the consequences – CCJs, bailiffs etc – can have a disastrous effect on your credit rating.
Is a personal loan the only way to fix my credit rating?
Not at all – if you have a credit card and use it every month to pay for something that costs up to 30% of the limit every month, and then pay this amount off the next month, you’ll see a steady and noticeable improvement of your credit rating.
However, if you have bad credit and can’t get a credit card to do this, or have a lot of credit card debt, then a personal loan is a good way to consolidate all your debts and start repairing your credit score.
At Bamboo, we offer personal loans of anywhere between £1,000 and £8,000 – if you’re considering consolidating your credit card debts or want to start repairing your credit score, why not see how much you could borrow? If you’re approved, you could be on your way to repairing your credit score within 24 hours. Representative APR 49.7%. A guarantor may be required.
- Author Jack Barclay
- Posted 13 December 2016