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Your credit score affects your ability to get a loan, how much you can borrow, the interest rates you qualify for, and sometimes even your eligibility to rent an apartment.
When you are apply for a personal loan, having a good credit score can help you get the lowest interest rates available. Here are three reasons why you should improve your credit score before taking out a personal loan.
Credible, it’s easy to view your prequalified personal loan rates from various lenders, all in one place.
1. You can get a lower interest rate
Your credit score is one of the most important factors that determines the interest rate you qualify for when you take out a personal loan — or any other type of loan. Generally speaking, the better your credit score, the better the interest rate you will qualify for, because the less risky you are in the eyes of a lender. And the best interest rates are generally reserved for borrowers with excellent credit.
The interest rate you receive on a loan is important for several reasons. First, it affects your monthly payment amount. It also determines your long-term costs, and a higher interest rate can cost you thousands of dollars more over the life of your loan than a lower interest rate.
2. Lenders will be more likely to approve you for a loan
Your credit score will also help determine if you qualify for a personal loan. If your score is too low, it can signal to a lender that you may not be able to make your loan repayments.
Whether you’re applying for a personal loan, mortgage, car loan, or something else, a lender will usually have a minimum credit score you’ll need to qualify. Some lenders list this minimum score on their websites, while others do not.
3. You may be able to borrow more
Another reason your credit score is so important when applying for a personal loan is that it can affect how much you can borrow. The better your credit score, the more confidence a lender has that you will repay your loan. In return, they can lend you a higher amount.
Some personal lenders offer loans of up to $100,000, but higher loan amounts may be reserved for borrowers with excellent credit. Meanwhile, someone with bad credit may only be eligible to borrow a lower amount.
But just because you qualify for a larger loan doesn’t mean you have to borrow the full amount. It’s important to only borrow what you need so you don’t pay extra interest.
What constitutes a credit score?
To increase your credit score in order to qualify for a personal loan, it is important to understand what factors affect your score. Your FICO score (the scoring model lenders use the most) is made up of five key categories.
- Payment history (35%) — Your payment history shows whether you’ve made your loan and credit payments in the past. The better your payment history, the better your credit score. On the other hand, a late or missed payment can cause your credit score to drop.
- Use of credit (30%) — Your credit utilization refers to the percentage of your available credit that you are using. You can find this by dividing the amount of your revolving credit you are using by your total revolving credit limits. Lenders generally prefer that your credit utilization stay below 30%.
- Length of credit history (15%) — This is the average age of your credit accounts, as well as the age of your oldest and newest accounts. It also shows how long you haven’t used certain accounts.
- Composition of credit (10%) — Your credit mix is made up of the different types of credit on your accounts, including credit cards, lines of credit, and installment loans. You don’t need to have one of each type of credit, but having more than one type can be helpful for your credit score.
- New Credit (10%) — New credit refers to all new accounts you have opened. Opening several accounts in a short period of time can be a bad sign for lenders, as it could indicate that you are struggling to manage your debt.
If your credit rating isn’t quite what you expected, there are several things you can do to improve it before applying for a personal loan. Some of them can give quick results, while others will take a little longer:
- Check your credit report. Checking your credit report can give you an idea of where you stand and what could be holding your score low, including missed payments. If you find errors on your credit report, you can dispute them with the appropriate credit bureau. Removing errors from your report can increase your score.
- Pay your bills on time. Your payment history is the most important factor that determines your credit score, so it only makes sense that simply paying your bills on time, every time, is the best way to boost your score in the long run.
- Repay revolving debt. Pay off credit cards and other revolving debts can reduce your use of credit, which can then increase your credit score.
- Increase your credit limits. In addition to reducing your debt to improve your credit utilization, you can also increase your credit limits. You may be able to do this by calling your credit card company or requesting a raise through your online account.
- Avoid applying for new credit. Applying for new credit just before applying for a personal loan can cause your credit score to drop slightly, which can temporarily lower your score by a few points.
If you’re ready to apply for a personal loan, Credible makes it quick and easy compare personal loan rates to find the one that best suits your needs.