You probably already know the basics to improve your credit—pay your bills on time and keep the balances on your credit cards low. If you’re a super credit conscientious consumer, you probably also know that a mix of different types of credit can also help improve your score. You may have even considered taking out a small loan to improve your credit.
It doesn’t really seem to make much sense, though, does it? Adding debt to get better credit?
However, some consumers may find that taking out a small loan can actually improve their credit scores! There are a few different ways that a small loan can actually help improve your credit score.
- Making timely payments on a small loan can have a big impact. Actually, making timely payments on your accounts accounts for roughly 35% of your credit score. As long as you make your payments on time every month, a small loan can improve your credit score.
- You can use a small loan to pay down debt. Your credit utilization, or the amount of your credit limit you’re using, also has a big impact on your credit score. Owing more than 30% of your credit limits can seriously drag down your credit score. However, if you use a small loan to pay off or pay down credit crd debt, this will lower your credit utilization, which can in turn raise your credit core. Also, the debt acquired with an installment loan is a different type of debt than credit card debt and it generally doesn’t have much impact—if any—on your credit utilization.
- A small loan adds to your credit mix. Your credit mix is the different types of accounts that you have. There are three different types of main credit accounts—open, revolving, and installment. Open accounts are accounts like utilities and cell phone bills, revolving accounts are credit cards, and installment accounts are loans. Your credit mix accounts for roughly 10% of your credit score, so adding an installment loan if you have only credit cards can actually give your credit score a little boost.
Does taking out a small loan to improve your credit score sound like a plan yet? Not so fast! There are still a few things that you should consider.
First, taking out a small loan will not improve your credit score right away. In fact, opening a new credit account may actually lower your credit score a bit at first. However, after making your payments on time for a few months, your score should improve. Keep in mind, though, that late or missed payments will also have a serious impact on your credit score—and not in a good way! Only take out a loan if the payments are manageable, the interest is reasonable, and you are positive that you’ll be able to make the payments every month. Otherwise, your plan to take a small loan to improve your credit could backfire.
Also, if take out a small loan to pay off your credit card debt, don’t make the mistake of running them up again. Keep your credit card balances low and pay your balance in full every month, if possible.
Finally, you may want to weigh the pros and cons of paying off an installment loan early, if you have the ability. On one hand, paying off an installment loan early means that you’ll have less debt and one less payment each month. On the other hand, though, once an installment loan is paid off, the account is marked as closed. While this won’t have a negative impact on your credit score, it won’t necessarily improve it either. If you can easily afford the payments, it may be best to simply make your monthly payments until the loan is paid off. The timely payments will be a little better for your credit score than a paid off loan.