If you find yourself with a bad credit score, an installment loan could be exactly what you may need to help improve your ratings in either a significant or minor way. Although installment loans are not meant to be used for everyone, this type of loan is easy to apply for and can have serious benefits to improving your credit score. If you apply for an installment loan without an understanding of how it works and how it can help you, then you can actually further damage your credit or simply result in no impact whatsoever. This is why it is important to have a firm understanding of what exactly an installment loan is before you jump into another financial responsibility.
Installment Loans – An Overview
An installment loan is when you borrow a specific amount of money that is to be paid back in a series of regular payments, known as installments. These payments are typically made on a monthly basis and can include anything from auto loans, student loans, and mortgages. Installment loans encourage a steady credit score improvement over a period of time, rather than a significant short-term improvement.
There are two main types of installment loans, the first being a secured loan and the second, an unsecured loan. In simplest terms, the secured loans are when the lender can reclaim a tangible item if the borrower fails to make the repayments, such as a vehicle or a home. Unsecured loans, on the other hand, do not consist of any item that the lender could reclaim in the event that the borrow does not pay. This type of installment loan includes student loans and personal loans, both of which typically have higher interest rates.
The key to using an installment loan to benefit your credit score is to make your payments on a timely basis and in the full amount that is in the loan terms. This is important in that it will demonstrate your ability to manage your debt responsibly and will improve your credit score. There are three primary ways in which an installment loan can help to improve your credit score rating.
1. Diversify “Credit Mix”
The first way is that an installment loan can diversify your debt. The means in which your credit score is determined is based on different categories. The first is your “payment history”, which makes up 35% of the score, and the second is “amounts owed”, which is 30%. The category that will help your credit stand out in regards to diversifying your debt is the “credit mix”, which makes up 10% of your score. Although this 10% is only a small part of your overall score, diversifying the different types of credit that you have can make a slight difference in your credit profile for the better. By further enhancing the variety of loans on your credit report, you will increase your credit score rating in the long run.
2. Save Money, Minimize Interest Rate
The second way in which an installment loan can improve your bad credit is that it can save you money if done correctly. This can be accomplished by paying a lower interest rate, so as to minimize the amount of time required to pay off your debt. Ensure that you are approved for an installment loan that does not exceed the interest rates of your other debts.
If you are applying for an installment loan and your bad credit is preventing you from getting a lower interest rate, then it may be a good idea to have a co-signer. By being able to pay off this installment loan quicker, you will save a significant amount of money in overall interest and the benefits that you reap from your installment loan will show in your credit score faster.
3. Improve Payment History
The most significant impact that an installment loan can have on your credit score, is in regards to your payment history. This point is why it is crucial to make your installment loan payments on time every month, especially since your “payment history” consists of 35% of your overall credit score rating. This is a significant aspect of your credit score that can drastically improve with a timely and well-managed payment of your installment loan.
It is typically not advised to take out an installment loan for the sole purpose of further improving your already-good credit. However, there is a specific type of installment loan for individuals interested in further improving their credit. This loan is known as a credit-builder loan, and is designed for those who either have no credit at all or minimal credit. This loan can help to create a strong credit profile, but must be used with extreme caution. If you fail to pay this loan on time, your plan in building a strong profile could in fact backfire, and you could actually create a bad credit rating.
When handling your debt and installment loan payments responsibly, you can make a beneficial difference in your credit score, as well as enhance your debt-management skills. Apply for an installment loan that works for you and your particular needs and watch as your bad credit transforms into a positive credit score profile.