If you’re strapped for cash but have pressing financial obligations, such as car or home repairs, or you need money for a vacation, a personal loan might be your best option. Personal loans can help you tackle common financial problems.
Your credit score is one of the most important factors lenders take into account when they consider your eligibility for a personal loan. The interest rate you receive will also be affected by your score. As you consider personal loans offered by local banks and credit unions, find out how your credit score is determined and what rates you can expect.
Your Credit Score and Why It Matters
Banking customers who use credit cards and take out loans have credit scores. Your score is a three-digit number that tells banks how trustworthy you are as a borrower. It is also a reflection of your repayment history and debts.
Your credit score is based on your credit report, which is a detailed summary of your credit activity over the years. Information on your report is collected by three major credit bureaus: TransUnion, Experian and Equifax. Your lenders report your repayment history to these organizations.
Credit bureaus use a scoring system based on the Fair Isaac Corporation (FICO). Your FICO score can range anywhere from 300 to 850. The better your score, the more liable you are to qualify for higher loan amounts and lower interest rates. If you have a low score, you might only qualify for small loans with high rates.
What Credit Score Do I Need for a Personal Loan?
As personal loans are unsecured — meaning they are not backed by any sort of collateral — interest rates can vary wildly based on your creditworthiness. Customers who used LendingTree to review personal loan rates in March 2015 saw rates as low as 3.99 percent and as high as 41.7 percent.
For personal loans, a difference of just 50 points on your credit score can affect your interest rate by several percentage points. Lanco Federal Credit Union, for example, offers the following personal loan rates based on your credit score:
- Customers with 750+ scores receive a 10.99% APR
- 700-749 scores receive a 11.99% APR
- 660-699 scores receive a 12.99% APR
- 620-659 scores receive a 15.99% APR
- If your score is under 620, your rate will be 17.99% APR
How Good Credit Helps You Save on Personal Loans
Raising your credit score will affect the affordability of your personal loan, saving you money on interest over time. Consider the following data from LendingTree:
- A personal loan borrower with a poor credit score who finances $10,000 for 48 months with a 30 percent APR can expect to pay $17,288.46 over the life of their loan.
- A borrower with an excellent credit score who receives a 8.18% APR will pay $11,758.80 over the life of the same loan.
In this scenario, the borrower with the higher credit score saves more than $5,500 over the course of a four-year loan. Those savings amount to nearly $1,400 each year.
Reviewing Your Credit Report
While lenders might also consider your employment history and monthly income when evaluating your creditworthiness, your credit report can make or break loan deals. Before applying for a personal loan, get a copy of your credit report and review it thoroughly.
“There could be items you’re not aware of that are bringing down your credit rating, such as unfavorable information from someone who has the same name as you, or being the victim of identity theft,” said Annie Sanchez, founder of website Debt Free like Annie. If you notice inaccurate information, you can easily dispute it by writing the credit reporting company.
When reviewing your report, you also want to look out for information that might raise red flags for lenders: “If you have paid late, gone over 30 percent of your credit limit, closed your oldest credit cards, applied for too much credit at the same time or stuck to only one source of credit, it’s possible that you could get denied or receive an unfavorable interest rate,” said Sanchez.
How to Raise Your Credit Score
Your credit score changes often. If your score is less than ideal, you can build healthy financial habits to improve your credit standing over time. You can even make it a mission to raise your FICO score 100 points in one year.
Correcting errors on your credit report can be a fast way to boosting your score. You can also aggressively pay down outstanding debts and set up automatic payments so you always pay bills on time. With an improved score, you can take out a personal loan with a lower rate. If you take extra care to pay back your loan on time, you can improve your credit score even more.