Many people are unaware that taking out a personal loan can actually help you build your credit and improve your score. How does this work?

Let’s Break It Down

Personal loans are most often treated as a fixed-term loan. Regular payments are made over a set period of time and end when the loan is fully paid. A credit card is a revolving line of credit, payment amounts vary and there’s no set end date. As a result, personal loans are treated more favorably from a credit score point of view. This is why taking out a personal loan can be used as a strategy to improve your financial profile and credit rating. In addition, while credit cards may provide flexibility and convenience, they often come with higher interest rates than personal loans, thus making it more costly to pay down debt. If done correctly, using a personal loan to consolidate your debt can be an extremely useful option in reaching your financial goals.

Here’s how to use a personal loan wisely to effectively boost your credit score and eliminate debt:

Research For The Best Rate

• First things first, it’s imperative to explore what different lenders are offering in terms of loan interest rates and fees. Be sure to compare these numbers and narrow down to the best lenders for your situation. These factors will be key in determining how quickly you achieve your goals and the amount of money you will save in the long run. Many sites allow you to compare loans making this process a bit easier.

Limit Applications

• Each loan you apply for results in a hard inquiry and can cause your credit score to drop a few points. To minimize the impact multiple applications will have on your credit score, stick to applying to one or two lenders.

Carefully Review Terms of Loan Agreement

• Once approved for a loan, take your time reading all the necessary paperwork. Be sure to thoroughly read and understand these key points when reviewing the agreement: Interest Rates, Origination Fee, APR, Penalties and Hidden Fees.

Only Borrow What You Need

• You may be approved for more than you need but don’t be fooled, borrowing too much can strain your budget and lead to missed payments. It may be tempting to accept a larger loan but stay firm and stick to your plan. This way you can establish a consistent payment history and avoid the burden of a large amount of debt to repay.

Free Up Available Credit

• One smart way to utilize a personal loan is to consolidate your credit debt and pay it off with your loan. This will reduce your credit utilization ratio which is factored into your credit score. Reducing this number can improve your score. Experts recommend not using more than 30% of each card’s credit limit.

Always Make Payments on Time

• One of the biggest influences on credit scores is payment history. Record of on-time payments can improve your credit while late payments can lower your score. Also, be sure your lender communicates to major credit reporting agencies. This way you can be confident you’re that you’re dutiful payments are recognized and boost your score.

Improve Your Mix Of Credit

• Having a variety of different types of credit, including both revolving and installment loans is a plus when it comes to determining your credit score. Having diversity amongst your credit will be viewed as a positive.

Avoid Increasing Your Debt

• Be diligent not to run up new debt on credit cards you’ve paid off with your personal loan. You want to avoid digging a deeper hole. Beware, as your credit score increases you may be eligible for other types of credit and receive a bunch of new offers. These offers may be tempting but you’ll want to stay strong to achieve your ultimate goal.

  You also don’t want to close your credit accounts, even if you have paid off your debt. Closed accounts will not be taken into consideration when calculating your score. A zero balance on your card will help your credit utilization ratio so you’ll want that to be factored in. Keep your credit card open and use it from time to time to ensure it’s not closed due to inactivity.

Monitor Your Progress

• Maintain a careful watch on your credit as you build it. Check your score from time to time and dispute any unfair or inaccurate claims as soon as you see them appear.