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What Is a Good Credit Score?

| Money Rates Columnist
min read

group-of-diverse-young-peopleThe credit score needed to get a personal loan is the most important piece of information available to lenders. A strong credit score is a sure path to low rates. Equally important, credit scores move. If you don't have a solid credit score at this moment there are steps you can take to drive it higher.

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Why Personal Loan Credit Scores Are Important

Personal loans are typically a form of unsecured financing. You don't have to pledge your car or home to get most personal loans. Without an asset to secure financing, lenders need an objective measure to limit their risk. That objective measure is your credit score. It's the quickest, fastest, and most understandable tool available to lenders.

Credit scores tell lenders how you handle credit. Fair Isaac, developer of the FICO-brand credit scoring system, uses five factors to calculate a credit score.

The FICO system uses five factors to establish scores.

  • Payment history (35%)
  • Level of debt (30%)
  • Age of credit history (15%)
  • Types of credit (10%)
  • Credit inquiries (10%)

As you look at these factors, you can see that borrowers control their credit score destiny. If you pay bills in full and on time you can do well in the payment history category - the most important factor. If you have a $15,000 line-of-credit but only use $2,000 you have a low level of debt usage, another big factor.

Minimum Credit Score Needed for a Personal Loan

Credit scores are crucially important, but they're not the only measure considered by lenders. Other important factors include your income and debt-to-income ratio (DTI). How do these factors come together?

  • Credit scores show your willingness to pay bills as promised.
  • Income shows whether you have the financial capacity to pay obligations.
  • The debt-to-income ratio measures the percentage of monthly income devoted to recurring payments for such things as auto loans, student debt, minimum credit card payments, and housing costs.

Lenders look at these measures with some flexibility. A low credit score can be offset by a lower debt-to-income ratio. A high DTI combined with a low credit score can doom a loan application. Applying for an outsize loan with a small income and the odds are against the borrower - the combination represents too much risk for many lenders.

What Is a Good Credit Score for a Personal Loan?

What is the minimum FICO score to get a personal loan? There are personal loans available for borrowers with credit scores at and below 600. The catch is that such scores suggest poor payment histories and a lot of lender risk. The result will be steep interest rates, meaning borrowers might be best off by not accepting such loans.

Personal loan lenders tend to assign applicants grades that reflect both their score and debt-to-income (DTI) ratio. If your DTI is under 36%, your credit score can be lower - perhaps even lower than 600. If your DTI is over 43%, you'll likely need a higher credit score or to pledge some asset and take out a secured personal loan. And if your DTI exceeds 50%, you'll need excellent credit to get approved for a personal loan.

You calculate your DTI by dividing your total debt payments (auto loans, rent, credit card minimums, etc.) by your gross (before tax) income. Don't count living expenses like food and utilities. If you earn $5,000 a month and spend $2,000 for rent and your other debts, your DTI is 40%. That's because $2,000 / $5,000 = .4, or 40%.

Credit Tiers: Poor, Fair, Good, Excellent

Here are the tiers MyFICO divides consumers into:

  • 620 - 639
  • 640 - 659
  • 660 - 679
  • 680 - 699
  • 700 - 759
  • 760 +

Generally, lenders consider any score under 620 to be poor and anything under 580 to be very poor. But the reason for your low credit score matters. If you've just used very little credit, or having used credit for very long, you'll probably get better treatment from lenders than an applicant with missed payments and a string of collection accounts.

How to Get a Personal Loan With a Low Credit Score

There are lenders who specialize in financing for those with low credit scores, high DTIs, and small incomes. You may have to take out a secured personal loan or enlist the help of a co-signer or co-borrower. So-called "second chance" or "credit builder" loans can help you establish or re-establish a credit history.

You have a decent chance of success if your DTI is low. Borrow smaller amounts with payments that you can successfully pay on time, and make sure the lender reports your good history to credit bureaus. A secured credit card can also help you increase your credit score.

But avoid so-called personal loans advertised as "personal loans with no credit check" or "personal loans for bad credit." In most cases, these are actually payday loans, check advances or auto title loans. If your credit score is so low that these are the only options, it's probably best to not borrow at all. Instead, take steps to have a better profile.

  • Start paying down debt. Even small reductions can begin to add up.
  • Make all payments in full and on time.
  • Start a budget - and stick to it.
  • Start a savings account so you don't have to borrow from payday and auto-title lenders. A small amount aside set aside weekly - say $5 or $10 - can add up. Once you have $400 in a savings account you can handle a lot of emergency costs with loans.
  • Ask friend or family with good credit to add you as an authorized user on their accounts. You don't use their credit. But when they make their payments, it also shows up on your credit history and helps your credit score.

How a Personal Loan Can Improve Your Credit Score

The use of a personal loan can significantly improve your credit standing. The reason is that a personal loan can impact a number of measures used in the credit scoring process. For instance, with the FICO-brand credit scoring system you might see these results.

  • The lender will make a "hard" credit inquiry to check your credit report and credit score. This action will actually reduce your credit score by a small amount for a short time.
  • Make payments in full and on time and your payment history will improve. This is the most important credit score factor.
  • Your level of debt will increase. However, as you repay your debt the level will decline and your unused credit will increase. That's a plus for credit scoring purposes.
  • If you use an personal loan to clear credit card balances, it can improve your credit score pretty quickly. That's because high credit card balances push your score down, and paying them off with an installment loan makes them go down.

In effect, one way to improve your credit score is to borrow and - of course - to repay as promised.

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