by Matt Frankel, CFP | March 12, 2019
A personal loan impacted my credit score in a big way. Here's what happened, and the reasons behind it.
I've written several times about how personal loans can potentially raise your credit score, so I figured I'd share my personal experience. I obtained a personal loan to consolidate some debts related to buying a house, and my credit score quickly soared. Here's how it happened, and why.
I obtained a personal loan a few years ago in order to consolidate credit card debt. The bulk of my credit card bills had originated when my wife and I bought our current home in 2015. We wanted to buy a "forever" home for our growing family, and as is often the case, our forever home has significantly more space than our starter home it was replacing.
More space meant a need for more furniture and other items. Since most of our available cash went towards the down payment on the house, we bought some of it using 0% APR credit card deals or similar methods -- for example, I bought a home theater system at Best Buy with 18-month deferred-interest financing and charged furniture to a credit card with a 0% intro APR for 12 months.
While I had made good progress repaying these debts, after a year the no-interest periods were coming to an end, so I decided to give the personal loan market a try. I ended up getting a 36-month personal loan offer with a significantly lower interest rate than I could expect to get from my credit cards after the introductory periods ran out, so I accepted the terms and used the proceeds to pay off my outstanding credit card debt.
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I know the FICO credit scoring formula quite well, so I figured that my score might increase after consolidating my credit cards with a personal loan. However, even I was surprised at the magnitude of the jump. Here's what my FICO® Scores from all three credit bureaus looked like before and after the personal loan was obtained and used to repay credit card debt.
|Credit Bureau||Before Applying for Personal Loan||Two Months After Applying||Change|
Data source: www.myFICO.com. Credit scores are FICO® Score 8, which is the most commonly-used version among lenders.
At first it may seem odd that my credit score would jump so much simply because I consolidated my credit card debt with a personal loan. After all, I still owed the same amount of money. However, there are two good reasons why this was the case.
First, there are two main categories of debts that can appear on your credit -- installment and revolving. Credit cards are a form of revolving debt, meaning that they are open-ended credit lines and don't have a set repayment time frame. On the other hand, personal loans are installment debt -- that is, once you make a specified number of loan payments, the balance will be paid off in its entirety. Generally speaking, installment debts are considered more favorably in the FICO scoring model than revolving debts.
In addition, in the process of using the personal loan proceeds to pay off my credit cards, my utilization percentage of each account dropped to zero. A big part of the "amounts owed" category of the FICO formula is the amount you owe on revolving accounts relative to your credit limits. By paying off the balances, this portion of my score looked dramatically better.
Now, it's important to mention that this was my personal experience. I'm not saying that a personal loan will necessarily raise your FICO® Score by 50 points. It depends on several factors, such as your score before obtaining the loan, the size of your other debts, and what you do with the proceeds of the loan. However, the point is that in the right circumstances, a personal loan can give your credit score a big boost.
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