By Sabrina Loh
Whether you’re aware of it or not, credit scores affect many aspects of your life. The better your credit score, the more benefits you have at your fingertips, such as better interest rates on cars and home loans, and easier credit approval.
A bad credit score can have wide-ranging consequences. Not only will it lead to higher interest rates and fewer loan options, it can also delay retirement by costing you more money over time.
One way to improve your credit score is with a personal loan. When used responsibly, a personal loan can help you to boost your credit score.
What is a personal loan?
Personal loans are consumer loans that can be used for just about anything you want. For instance, financing your dream wedding, starting a company, putting down the downpayment for a house, and even paying off credit card debt that’s getting out of hand.
This is unlike student loans, car loans, or home loans, which are only applicable for specific expenses.
Just like any loan, the money you borrow must be repaid over a fixed period of time with interest. You can get a personal loan from a traditional bank, digital bank, credit union, or online lender.
Types of personal loans
There are two types of personal loans — secured and unsecured.
Secured personal loans require collateral as a condition for borrowing, such as money in a savings account, car, or even a property. This is so that the lender can seize the collateral if the borrower defaults on the loan.
Unsecured personal loans, on the other hand, require no collateral to borrow money but could have higher interest rates.
How much can I borrow?
That depends on your credit score and credit history.
Banks refer to your CCRIS report to assess your credit history and gain insight into your past repayment habits. This report stores your credit history from all financial service providers in Malaysia for up to 12 months.
A credit score (CTOS), on the other hand, is a 3-digit numerical rating that evaluates your creditworthiness based on your credit history.
A high credit score increases your chances of getting a loan approved, whereas a bad credit score risks getting rejected.
This table breaks down credit score ratings:
Check your CTOS score here.
How personal loans can improve your credit
A personal loan that’s repaid in a timely manner can help you to improve your credit score in several ways.
If you have multiple credit card debts, you’re likely paying interest on all of them separately. Taking out a larger personal loan can help you to pay off all these debts in a single payment, get a better interest rate, and increase your credit score.
For example, if you have three outstanding balances on three credit cards, instead of making three payments every month at three interest rates, a debt consolidation personal loan allows you to borrow money to pay off all three debts at once. After which you’ll pay back the personal loan with one payment each month at a single interest rate.
Lower credit utilisation ratio
Credit utilisation ratio is the ratio between how much you owe and how high your credit limit is, combined across all your credit cards.
The closer you are to maxing out your credit cards, the more you’ll be flagged as high risk, hence your credit score will be docked.
By using a personal loan to pay off all your credit card debt, you free up your credit card balance, so it appears in the system that you’re only using a small bit of your available credit. This makes you look more trustworthy to lenders and helps your credit score.
However, for this to work, you’ll have to be responsible and continue keeping your credit card debt low.
Building payment history
Paying your personal loan instalments on time every month has a positive effect on your credit score because it demonstrates your ability to handle debt responsibly.
Better credit mix
If you only have one type of credit, such as credit cards, a personal loan can diversify your credit portfolio, thus boosting your credit score.
Lenders like to see that you can handle different types of debt, so this can benefit you in the long run.
Length of credit history
The length of your credit history is one of the primary factors in building a positive credit profile. A longer credit history will show you being responsible with credit over time, strengthening your credit score.
When you should think twice about getting a personal loan
Getting a personal loan can help you to improve your credit score when used responsibly. However, there are ways that it can also hurt your credit score.
It’s just as important to understand the risks before you apply for one.
Just like any loan, late payments will hurt your credit score. The later the payment and the more you’re past due in paying, the worse the effect on your score.
Acquiring more debt
Even when using a personal loan to consolidate high-interest credit card debt, it’s crucial that you change the habits that got you into trouble in the first place.
For example, if you use a personal loan to pay off debt on a credit card, but overcharge on your credit card again, you’ll end up with a maxed-out credit card debt plus a personal loan debt to pay off.
Whenever you apply for any type of credit, lenders will run a credit check on you. This results in a ‘hard inquiry’ on your credit report and causes your credit score to drop.
Although this doesn’t usually last longer than a few months, it can be detrimental if you’re applying for multiple personal loans and end up with multiple hard inquiries.
Make sure you read the fine print to understand what fees are associated with the loan to avoid being blindsided. Having an average or low credit score could have you flagged as a high-risk borrower, hence accruing more fees.
BigPay Personal Loans
As part of our mission to make banking accessible for everyone, we’ve launched Malaysia’s first 100% digital loan, which eliminates the hassle of applying for traditional personal loans.
No need to wait in line at the bank with confusing documentation. Just download our app and click apply to get your loan disbursed to your BigPay app in as little as 5 minutes.
We promise you’ll love it.
Learn more about it here.
The Bottom Line
A personal loan can be a powerful tool when it comes to improving your credit score, as long as you’re responsible in paying it off promptly on time.
But remember to be conscientious of the risks involved and compare quotes from lenders to find one that suits your needs.
Tune into our BigPay blog every week to improve your financial knowledge.