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Using Personal Loans to Improve Your Credit Score: A Step-by-Step Guide

Updated: May 17, 2023

Have you ever wondered why a good credit score is essential to achieving financial stability? Well, a credit score is that three-digit number that represents your creditworthiness and likelihood to repay your debts. When you achieve a favourable score then you are more likely to get approved for loans, credit cards, and rental applications.

How can you improve your credit score? You can always get a personal loan as a useful tool for improving your own score. Unlike credit cards, it has a fixed repayment term and interest rate, making them easier to manage and pay off. Additionally, it can be used to pay off high-interest debts, such as credit card balances, which can positively impact your score.

According to credit reporting agency Equifax, making timely payments on a personal loan can have a positive impact on your credit score. Additionally, using a personal loan to consolidate high-interest credit card debt can improve your credit utilisation ratio - the amount of credit you're using compared to your credit limit.

How to improve credit score?

In a study conducted by Finder, most of the respondents reported that taking out a personal loan helped improve their credit score. It also found out that borrowers who used personal loans for debt consolidation saw their average credit score increase significantly. Despite the advantages, a personal loan can also have a negative impact on your credit score if not done right.

The average credit score for Australian adults is about 550. In practical terms, that score means that there is one in twelve chances that you will encounter a negative event, such as a loan default, recorded in your credit report within the next year. If you happened to have a lower score then you will be considered a riskier borrower.

Every Australian should consider their financial situation and ability to make loan repayments before applying for one. Take time to read the fine print of the loan agreement before signing. Consider looking around for the best rates with favourable terms and conditions.

To help you get started, we are sharing a step-by-step guide that will cover topics such as understanding your credit score and credit report, managing your credit limit, and working with a credit repair company. By following these steps, you can take control of your credit and work towards achieving financial stability.

Step 1: Understand Your Credit Score and Credit Report

The first step in improving your credit score is to understand what it is. As this figure represents your creditworthiness, it's calculated based on several factors, including:

☑️ Payment history (35%)

☑️ Amount owed (30%)

☑️ Length of credit history (15%)

☑️ Credit mix (10%)

☑️ New credit (10%)

You can obtain a free copy of your credit report from credit reporting agencies once a year. You can also request a copy of your credit report if you have been denied credit, insurance, or employment within the past 60 days.

Reviewing your credit report regularly is essential to ensure that all the information is accurate and up-to-date. Errors on your credit report, such as incorrect account information or fraudulent accounts, can harm your credit score.

Step 2: Pay Your Bills on Time

Payment history is the most significant factor that affects your credit score, accounting for 35% of your overall score. It is essential to pay your bills on time to maintain a good credit score as any late or missed payments can have a significant impact on your credit score. It can even stay on your credit report for up to seven years.

An effective way to pay your bills on time is by setting up automatic payments or reminders. Depending on your bank, it can be set up on your bank account so that bills can be deducted from your balance every month. You may opt to set up reminders to notify you when your payments are due. This can help you avoid late or missed payments and maintain a good credit score.

In addition to negatively impacting your credit score, late payments can result in late fees, increased interest rates, and even account closures. If you are struggling to make payments, it is recommended that you contact your creditors and work out a payment plan.

Step 3: Manage Your Credit Limit

Credit limits are set by lenders to refer to the maximum amount of money you are allowed to borrow just like the credit card you signed up for. It is recommended to keep your credit utilisation rate below 30% so if you have a $10,000 credit limit then you should not use more than $3,000 at any given time.

It is also essential to pay off your credit card balances in full each month to avoid accruing interest and accumulating debt. High credit card balances can negatively impact your credit score as it would indicate that you are struggling with debt.

Step 4: Avoid Applying for Too Many Credit Cards

You have to keep in mind that lenders will perform due diligence on your credit report every time you apply for a new credit card. These inquiries can negatively impact your credit score, as they indicate that you are actively seeking credit. Each hard inquiry can lower your credit score by a few points, and multiple inquiries can have a more significant impact on your credit score.

It is recommended to space out your credit card applications to avoid multiple hard inquiries in a short period. Applying for multiple credit cards at once can indicate that you are in financial distress, which can negatively impact your credit score. Although there is no recommended frequency of credit card applications, you probably have to wait for at least six months and take a closer look at your financial situation and credit history first before considering one. Only apply if you need it or there is a greater chance of getting approved.

Step 5: Work With a Credit Repair Company

Have you found errors and discrepancies on your credit report? Are you struggling with a low credit score? If so, you may have to work with a credit repair company to help you dispute inaccurate or incomplete information on your credit report and work with lenders to negotiate payment arrangements.

Credit repair companies provide expert advice and guidance to improve your credit score, which may include paying down debt, disputing inaccurate information, and negotiating with lenders. However, it is essential to choose a reputable company, as many fraudulent ones prey on individuals struggling with debt and poor credit. The reputable ones don't make unrealistic promises as they are transparent about their fees and services.

Final Words

Maintaining a good credit score is crucial for financial stability, as it can impact your ability to obtain loans, credit cards, and even employment. To achieve that, personal loans can be used as an effective tool as long as you use them responsibly.

By following the step-by-step guide provided above, you can improve your credit score and increase your chances of obtaining loans and credit cards with favourable terms and conditions. Just keep yourself grounded by borrowing only what you can afford to repay. Start achieving your financial goals by working with experts now.

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