Under certain circumstances taking out a loan can raise your credit score. How can borrowing more improve your financial profile? A loan can raise a credit score when the consumer has no installment loan in his credit profile while burdened by high interest revolving credit card and store card debt pushing up against each card’s borrowing limits.
Adding the installment loan will be a new type of loan on the account. This will boost the “mix of credit” category which accounts for 10 percent of the total components of the FICO credit score picture. Debt to available credit ratio on installment loans does not carry nearly as much negative weight as debt to available credit does with revolving debt such as credit cards.
As an aside, there is another way to improve your mix of credit. Open an account at self.inc which has a neat trick of reporting your payments to a savings account you open with them as if they were installment loan payments. Sounds too good to be true I know but check this option out for yourself for as little as $25.00 per month.
The funds received from the installment loan must now be used to pay down the credit card debt to a reasonable ratio against the credit limits of the card. When the lower credit card balances are reported to the credit reporting agencies at the close of the next statement there will be an immediate jump in the credit score.
The installment loan typically has a much lower interest rate than the credit card debt did resulting in a win-win situation all the way around. It will take several months for the installment loan’s addition to your credit profile to have a positive effect on your score.
Loan can Raise Your Credit Score Limitations
As with any new loan there must first be a hard inquiry which may cost you a few points for up to a year with whatever credit reporting agency it is made with. Inquiries are only counted in a negative way by FICO for one year even though they remain on record for 2 years. Their effects are temporary and tend to dissipate quickly.
Many consumers let worry about inquiries stress them far more than they should. Focus more on the other components of your score.
How a New Loan Affects Credit Age
Credit Age accounts for 15 percent of your total FICO score. Credit age is divided into 2 sections. Average age of accounts is 7.5%. The age of your oldest account is the other 7.5%.
Your new loan will not affect the age of your oldest account. That 7.5% of this category will remain untouched. The new credit line entry will affect your average age of accounts to a greater or lesser degree depending on how many older accounts you have. If you have several older accounts they will absorb the impact of the brand new entry. The impact of the new account will be minimal. If you only have one or two other cards there will be a small but noticeable impact lowering the average age of your accounts.
Loan can Raise Your Credit Score Reality Check
The fact that the consumer had the problem of maxed out credit cards in the first place means that there will not be a terribly robust credit score when the installment loan is applied for. This is always the “Catch 22” no one seems to remember when talking about the wonderful move of losing the high interest revolving debt by taking out new balance transfer credit cards. This is the reason those who need the new loan the most are those who will be offered less than the amount they need to truly make a big change in their situation.
A consumer whose credit picture is healthy in every other way should still have a decent enough credit profile that a loan can raise their credit score enough for a fast, effective and lasting gain in their financial picture.
When applying for the installment loan from one of the peer to peer lenders such as Lender’s Club or anywhere else the high credit card debt pushing the credit score down means a higher interest rate and a lower loan amount will be offered. To make this strategy work best the rest of the consumer’s credit profile needs to be in tip-top shape.
Loan Can Raise Your Credit Score Ninja Trick
And finally a suggestion for bonus credit score points. After you have realized the gains to your credit score as outlined above call the card’s customer service and ask for a credit limit increase. Your new high score and lower balances will help you become entitled to an increase in your credit limit. The increased credit limit will then add even more points to your score because it will increase your debt to available credit ratio by increasing your available credit. That is, of course, as long as your debt doesn’t increase at the same time.