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Business News/ Money / Want to improve your credit utilisation ratio? Here's how a personal loan can help
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Want to improve your credit utilisation ratio? Here's how a personal loan can help

Utilising a personal loan to consolidate high-interest credit card debt, preferably at a reduced interest rate, is a viable option. Clearing your credit card balances diminishes your credit utilisation ratio (total credit used divided by total credit limit).

Maintaining your credit utilisation ratio below 30% is typically advised for maintaining a favorable credit score.Premium
Maintaining your credit utilisation ratio below 30% is typically advised for maintaining a favorable credit score.

Personal loans can indirectly improve your credit utilisation ratio. Although they are not included in the utilisation ratio since they are installment loans, they can be used to pay down revolving debt, such as credit cards, which do impact your utilisation ratio. The following points detail the intricate relationship between personal loans sought and credit utilisation ratio.

  • Your credit utilisation ratio is the amount of credit you’re using compared to your total credit limit. Experts recommend keeping it below 30% for a good credit score, with lower ratios, such as below 10%, being even better for your credit score.
  • It can make sense to combine high-interest credit card debt with a personal loan, particularly if you can obtain the loan with a lower interest rate. Using this method could help you pay off your debt more quickly and potentially save money on interest over time. 

Certainly, it’s simpler to balance one personal loan payment each month than several credit card payments. Your credit score can be raised by reducing your credit utilisation ratio and paying off credit card debt.

  • Clearing your credit card balances surely reduces your credit utilisation ratio. This is related to the formula: credit utilisation ratio = total credit used divided by total credit limit. Paying off your credit card bills reduces the "total credit used" element of the equation, resulting in a lower ratio.

The most important thing to keep in mind is that since personal loans are installment loans, they are excluded from the credit utilisation ratio computation. However, they can be a useful tool for deliberately lowering credit card debt, which has an impact on your utilisation ratio.

Here are some additional things to think about:

  • Your overall debt increases when you take out a personal loan. You run the risk of missing the payments if you can’t comfortably make the payments each month on top of your current financial obligations. Prior to applying for a personal loan, make sure you are in a financially stable position because missing payments on any kind of loan can negatively impact your credit score.
  • Using a personal loan to pay off high-interest credit card debt is the main way to raise your credit score. After debt consolidation, if you start using credit cards again, your situation will likely revert to its previous state: high credit utilisation and possibly damaged credit score.

Seeking advice from a credit counselor or financial advisor before pursuing a personal loan to improve your credit score is highly advisable. They can evaluate your individual financial circumstances, including your income, expenses, and current debt, to determine if a personal loan is the most appropriate choice for you. While utilising a personal loan can be beneficial, it’s not universally suitable for everyone. With their expertise, a credit counselor or financial advisor can offer invaluable guidance, ensuring you make the optimal decision for your financial well-being and credit score.

Frequently Asked Questions (FAQs)

Q. What minimum credit score is required to secure a personal loan?

A personal loan cannot be obtained with a minimum credit score. When evaluating your loan application, lenders will undoubtedly take your credit score into account. This could have an impact on the terms of the loan that is offered to you as well as your chances of being approved.

This is a basic explanation of how personal loans are impacted by credit ratings:

  • Greater numbers (750+) are frequently considered exceptional. Borrowers in this range of credit scores are more likely to get approved for loans with the best interest rates and terms.
  • Equitable score (650–749) - Although the interest rates on your personal loan might be higher than those given to applicants with excellent credit scores, you might still be eligible.
  • Lower scores (Below 650): It becomes harder to get approved for a personal loan, and even if you do, you’ll probably pay a lot more in interest and possibly have less favorable terms.

These are only average ranges, and that every lender will assess borrowers based on different standards. It’s wise to inquire about the precise credit score requirements of the lenders you are thinking about using.

Q. How to get a personal loan?

The typical process for obtaining a personal loan:

  • Evaluate your needs and financial situation.
  • Review your credit score and credit report.
  • Research and compare different lenders.
  • Pre-qualify for loans whenever feasible.
  • Collect necessary documentation.
  • Complete and submit a formal loan application.
  • Wait for a decision on your loan application.
  • Thoroughly review the loan agreement before finalising.

Q. What steps can you take to enhance your credit utilisation?

To enhance your credit utilisation, start by reducing your debts to below 30% of your available credit. Additionally, consider increasing your credit limit or opening a new card to utilise more credit, or maintain a card with a zero balance but keep it open. However, the most effective method to improve your credit utilisation is consistently paying off your debt on schedule.

Q. What’s the process for determining a credit utilisation ratio?

Calculating your credit utilisation ratio involves summing up all your credit accounts. Initially, total the outstanding balances and credit limits. Next, divide the total balances by the total credit limit, and multiply the result by 100 to obtain your credit utilisation ratio as a percentage.

Q. How does credit utilisation work?

The revolving credit of a borrower is the main focus of the credit utilisation ratio. It's a figure that contrasts the total debt owed by a borrower with the total amount of revolving credit that lenders will allow.

One key factor influencing your credit score, which in turn impacts your creditworthiness, is your current debt-to-income ratio. For both revolving and non-revolving credit, this percentage is used. Keep your use of revolving credit below 30% in order to preserve a higher credit score.

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Published: 07 Jun 2024, 01:38 PM IST
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