As long as you make on-time payments in full, you can use a personal loan to build credit. Notably, if you have bad credit or don’t have consistent earnings, you might end up with high interest rates. But if you have a steady income and good enough credit to qualify for low rates, a personal loan may be a good option — just make sure you can pay back the loan amount before borrowing.
Establishing and building a good credit history is crucial for any adult. Your credit score affects your ability to take out loans, rent an apartment, get utilities turned on, and more. One way to build credit is to take out a personal loan. Let’s look at how personal loans can help build your credit score when used responsibly.
How Personal Loans Can Build Credit
There are a few key ways that taking out and repaying a personal loan can contribute to building your credit
Payment History
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Your payment history makes up 35% of your FICO credit score. This refers to your track record of making payments on time each month.
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By taking out a personal loan and consistently making the monthly payments on time, you demonstrate reliability. This will improve your payment history and credit score.
Credit Mix
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Having a mix of different types of credit accounts for 10% of your credit score. This includes credit cards retail accounts mortgages, auto loans, and personal loans.
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Adding a personal loan to your existing credit mix shows lenders you can handle multiple types of credit responsibly. This diversity improves your credit mix.
Credit Utilization
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Your credit utilization ratio, which is how much of your available credit you’re using, makes up 30% of your credit score. The lower your ratio, the better.
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A personal loan provides you with a lump sum of cash upfront without increasing your revolving credit utilization like a credit card does. This can lower your overall utilization.
As you can see, used properly, a personal loan can positively influence key scoring factors that make up 75% of your credit score. Next let’s look at some dos and don’ts of using personal loans to build credit effectively.
Dos and Don’ts of Using Personal Loans to Build Credit
If you’re considering a personal loan to build your credit, make sure you follow these dos and don’ts
Do: Shop Around for the Best Rate
- Compare interest rates and fees from multiple lenders. A lower APR saves you money.
Do: Review the Loan Terms Thoroughly
- Read the fine print so you understand the full terms and any penalties for late/missed payments.
Do: Make All Payments On Time
- Set up autopay if needed and pay on time each month. Late payments severely damage your credit.
Don’t: Apply Everywhere
- Too many applications create hard inquiries that can lower your credit score temporarily.
Don’t: Borrow More Than You Need
- Only take enough to help build your credit – overborrowing can hurt your credit utilization ratio.
Don’t: Take on Additional Debt
- Don’t open new credit cards or loans while paying off your personal loan. Too much debt can lower your score.
Requirements for Qualifying for a Personal Loan
As a major borrowing decision, lenders have requirements you must meet to take out a personal loan:
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Income – Most lenders require regular income from a job, retirement, or other source.
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Credit score – Minimum scores vary but are often 640+ for personal loans. Higher scores get better rates.
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Debt-to-income ratio – Your monthly debts divided by income. Lenders want to see you can afford the new loan payment.
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Collateral – Personal loans are unsecured, meaning you don’t put up an asset as collateral.
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Age – Many lenders require borrowers to be 18+ years old.
As long as you meet the requirements, using a personal loan responsibly can be an effective way to build your credit. Just be sure to borrow conservatively, make payments on time, and avoid taking on additional debt. With smart practices, a personal loan can strengthen your credit profile.
How to use a personal loan to build credit
A personal loan can demonstrate your ability to manage debt. Here’s how lenders may view your decision to take out and fully repay a personal loan:
- Build up a payment history. A lender wants to know that you’ll repay any money you borrow. Demonstrating a consistent repayment history using a personal loan can show future lenders that you’re a reliable borrower. Your payment history makes up 35% of your FICO credit score, so be sure to keep up with what you owe each month.
- Responsibly manage your credit. Lenders evaluate you based on how you use your credit — how much debt you take out, what type of debt you have and your repayment history. A personal loan can help demonstrate this as long as you don’t borrow too much and can keep up with payments.
- Improve your credit mix. Your credit mix accounts for 10% of your FICO Score. Having multiple types of credit accounts can help your rating. If you have little variety in your credit history, taking out a personal loan could provide a boost to your credit score.
- Lengthen your credit history. The length of your credit history makes up 15% of your FICO Score. If you have little to no credit history, lenders may be more cautious about offering you money. A personal loan can extend your history as a borrower and boost your score.
Does getting a loan build credit?
Yes, getting a personal loan can build credit, but only if the lender reports your payments to the credit bureaus. You’ll borrow a fixed amount of money from a lender, which you’ll then pay back in intervals over the course of the loan term, with interest.
When you make on-time payments, and they’re recorded on your credit reports, it can help boost your credit score. On the other hand, missed payments can cause your credit score to drop by as many as 180 points. Be sure to keep up with payments, or you could hurt your credit score.
Dos and Don’ts of Taking Out a Personal Loan to Build Credit
FAQ
Will a personal loan raise my credit score?
How fast does a loan build credit?
Is it smart to take a loan to build credit?
Can personal finance build credit?
Is a personal loan a good way to build credit?
A personal loan can be a good way to build credit, but only if your credit history is already solid enough to get loan terms that aren’t too costly. If you have no credit history at all or credit that needs a ton of work, a credit-builder loan or credit card may be better options.
Should I get a personal loan?
Having a personal loan can help with this, as long as you pay it back according to the terms and don’t pile up too much other debt. Length of credit history: A longer credit history can show you displaying positive credit activity over time, strengthening your credit profile.
How can a personal loan benefit my credit?
There are three main ways a personal loan can benefit your credit: Build a positive repayment history. When you take out a loan, lenders report your payment activity to the three major credit bureaus — Experian, TransUnion and Equifax.
Can a personal loan improve your credit score?
As you make on-time payments on your personal loan, you’ll be building a positive payment history and potentially improving your credit score. Amounts owed: Using a personal loan to consolidate credit card debt can significantly improve your credit if it helps you reduce your credit utilization ratio.