3 Ways an Installment Loan Can Help Your Credit Score
If you ever feel like your credit score is totally beyond your control (like the weather or your utterly doomed fantasy football team), then it might be time to adjust your thinking. After all, your credit score is merely a reflection of the information in your credit report, which is itself a reflection of how you handle your debt. You can’t change the stuff you did in the past to hurt your score, but there are actions you can take to improve it today.
It's possible to improve your FICO score by taking out a personal installment loan. Unlike short-term payday or title loans, an installment loan is designed to be paid off in a series of simple, manageable payments over the course of the loan’s term.
While you shouldn't take out an installment loan just for the purpose of building your credit, if you need an emergency financial solution, building your credit could be a silver lining with an installment loan.
Here are three ways that a safe, affordable installment loan may help you improve your credit score. (To read the details about installment loans, you can visit the TheLending Guide to Installment Loans here.)
1. Diversify Your Debt
When the good people at FICO are creating your credit score, they are sorting all the information on your credit report into five different categories. The two most important categories are “Payment History” (which makes up 35% of your score) and “Amounts Owed” (30%).[1]
But one of the other three categories is “Credit Mix”, which determines 10% of your score. “Credit Mix” refers to the different kinds of debt you owe: credit card debt, personal loan debt, student debt, auto debt, mortgage debt, etc. The more diverse your credit mix, the better your credit rating.
If you have a lot of credit card debt, taking out an installment loan to pay some of it off would also help diversify your credit mix. And that more diverse mix could help improve your credit.
Best Practices: Don’t take an installment loan just for the sake of taking one out. That would add to your total debt load and—if you fail to repay it—lower your credit rating.
2. Save You Money
You know what’s a great way to raise your credit score? Owe less debt. (Shocking, we know.) And you know what’s a great way to less debt? Score a lower interest rate. The less you’re paying in interest, the less you’ll pay overall—and the faster you’ll be able to pay your debt down.
First things first: if you cannot get approved for an installment loan with an equal or lower rate than your other debt (credit cards, payday loans, title loans), then it’s probably not worth it. Consolidating high-interest debt into an affordable, reliable installment loan can be a great way to save money (read more in Debt Consolidation Loans – An TheLending Q&A with Ann Logue, MBA, CFA). But if you’re going to be paying a higher interest rate? Not so much.
But scoring a lower interest rate isn’t the only way you can owe less through an installment loan. You see, the longer any piece of debt is outstanding, the more you’ll end up paying in interest overall. The shorter the loan, the less it costs. Most installment loans are structured to repaid over the course of a few years—and that’s with the borrower paying only their minimum payments. Compare that to your typical credit card: with only minimum payments, that card could take nearly a decade to pay off! That’s thousands of extra dollars in interest.
Paying less money on your debt will also help you pay down your debt fast. And the sooner you pay that debt off—or at least pay it down—the faster that change will be reflected in your credit score.
Best Practices: Most installment loans are amortizing, which means that they can save you money compared to rolling over a similar payday or title loan.
3. Improve Your Payment History
As you’ll recall, your payment history determines 35% of your score overall. This means that making your installment loan payments on time every month will go towards improving that chunk of your score. If you don’t have a great history of on-time payments, it just might help to start fresh!
Of course, that all depends on your lender actually reporting your payment information to the credit bureaus. And if you have bad credit, you might find yourself dealing with lenders who don’t report any payment information at all. This is especially true for most payday and title lenders. While many of their customers will be grateful that these lenders don’t report payment information, someone who’s looking to be responsible and improve their credit score will not.
References:
- “What’s in my FICO Scores.” MyFICO.com. Retrieved October 4, 2016 from http://www.myfico.com/crediteducation/whatsinyourscore.aspx