Wondering what constitutes a good credit score?
Your credit profile is an indicator of your financial health to lenders. The better it is, the more access you have to better financial deals and opportunities, such as lower interest rates. Personal finance writer LaToya Irby explains that five factors influence your credit score:
- Payment history (this accounts for 35 percent of the score)
- Level of debt/credit utilization (30 percent)
- Age of credit (15 percent)
- Mix of credit (10 percent)
- Credit inquiries (10 percent)
Two of these factors, credit utilization and mix of credit, are especially important when debating the best option for you to borrow money.
Keep Your Credit Utilization Low
The type of debt you carry matters, and debt is broken up into two different categories on your credit report, revolving loans, and installment loans.
Revolving loans have no fixed repayment terms, like credit cards. You have a limit on these accounts, and as long as you make the payments to free up available credit you can keep using it. These accounts demonstrate to lenders that you can handle loans that are not paid off on a regular schedule.
Installment loans do have a fixed repayment schedule. Personal loans are installment loans. There is no fluctuation of credit limits and outstanding debt, which provides a steadier indication of your ability to manage spending. These types of loans are treated differently from revolving credit accounts.
Your credit score is affected by the ratio of outstanding balances to available credit on revolving accounts. This ratio is called credit utilization. As your balances on revolving accounts go up, your credit scores go down because the spending balances are approaching their credit limits. When this happens, your credit utilization ratio is too high and indicates to lenders an inability to meet debt repayment obligations.
Whereas overuse of credit cards has a negative impact on your credit score through high credit utilization and lack of variety of credit, personal loans could improve your credit by providing you with a variety of credit types and lowering your revolving credit utilization.
Ensure a Good Mix of Credit
If you find yourself with too much credit card debt and a less-than-ideal credit score, consolidating your debts can have the biggest positive impact on your credit score. A good balance between the two of these in your credit profile helps to define your financial health.
Consider replacing credit card debt with a personal loan if you can qualify for a lower interest rate. The same amount of debt on an installment loan may not be as detrimental to your credit score as a revolving loan that is almost maxed out.
So, if your credit score is low and you have multiple credit cards with balances, consolidating those debts and taking out a personal loan to pay one debt may improve your credit score.