How a Personal Loan Can Change Your Life
Under the right circumstances, a personal loan can save you money and boost your credit score
Taking out a loan can seem scary—after all, you do have to pay it back with interest. But you may be surprised to discover a personal loan can actually help strengthen your financial standing.
Everybody’s doing it
First, if you’re contemplating a personal loan, know that you are not alone. A Gallup analysis found that 20 percent of Americans have a personal loan, including nearly a quarter of millennials and Gen X'ers. And another survey found that almost 16 million consumers had a personal loan at the end of 2016, the highest level since at least 2009.
While people take out personal loans for a wide variety of reasons, in certain circumstances, it can be a very sound financial move.
Here are three smart reasons to borrow:
1. A personal loan can reduce your debt
The top two reasons people apply for a personal loan are both wise ones: Debt consolidation and paying off credit cards. Consumers often choose a personal loan because it is likely to have a lower interest rate than other debt such as credit cards. That can be a huge savings, considering that the average household has nearly $8,000 in credit card debt. A personal loan can be a savvy way to dig out from under big balances because you can pay them down faster—and pay less in the long run thanks to lower interest rates.
2. A personal loan can boost your credit
One of the factors used to calculate your credit score is your "credit mix," and if you use different types of credit responsibly. While credit cards are known as "revolving loans," since they don’t have a fixed repayment term, a personal loan is an "installment loan," meaning it has a prescribed repayment term (x $ for y months). Credit bureaus like to see a variety of revolving and installment credit, and—more importantly—that you can make on-time payments for all of them.
In addition, if your plan is to move debt from a credit card to a personal loan, you’ll also be lowering your "credit utilization." That's the amount of credit you are using compared to the limit on your card. It's also the second most important factor (just behind payment history) comprising your credit score. Ideally, your utilization should be below 25 percent of your available credit, and when you use a personal loan to pay off some or all of your credit card debt, your utilization rate decreases.
3. You’re likely to pay it back
Of course you are diligently working toward paying off all your loans and debts, but interestingly, one study found that consumers prioritized payments on a personal loan even before other credit responsibilities, like auto loans, mortgages, and even credit cards. Just remember that on-time payments on all of your accounts are the key to healthy credit.