In a Nutshell 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. Editorial Note: Intuit Credit Karma receives compensation from third-party advertisers, but that doesn’t affect
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Having strong credit opens doors to more affordable lending options, like low-rate credit cards, auto loans, and mortgages. But establishing credit can seem tricky, especially if you’re just starting out or rebuilding from past mistakes. You may wonder – can taking out a personal loan help build your credit?
The answer is yes, personal loans can be an effective credit-building tool when used responsibly. By adding a new type of credit account to your history and demonstrating responsible repayment over time, personal loans can give your credit score a nice boost.
In this comprehensive guide we’ll explain how personal loans can impact your credit by looking at
- The factors personal loans help improve
- Strategies for using loans to build credit
- Risks to be aware of
- Alternatives to consider
- Tips for success
Understanding the nuances will help you decide if a personal loan is your ticket to stronger credit
How Do Personal Loans Help Build Credit Scores?
Personal loans directly influence three major factors that comprise your FICO credit score:
1. Payment History
This holds the most weight, accounting for 35% of your score. Making consistent, on-time payments shows lenders you can handle credit responsibly. Personal loans provide a way to add positive payment data to your credit report.
2. Credit Mix
At 10% of your score, this reflects experience managing different types of credit like installment loans and credit cards. Personal loans can diversify your credit mix.
3. Credit Utilization
Around 30% of your score, this measures how much of your available credit you’re using. Taking out a personal loan provides more total credit, which can lower your overall utilization.
Strategic Ways to Use Personal Loans to Build Credit
Simply taking out a personal loan won’t automatically improve your credit. To effectively build your score, be strategic with:
Loan amount – Borrow only what you need and can conservatively afford. Avoid maxing out your limit.
Interest rate – The lower the rate, the less interest you’ll pay, saving money. Shop around for the best rate you can qualify for.
Loan term – Opt for a term that fits your budget but isn’t overly long, such as 2-3 years. This demonstrates responsible borrowing.
Payments – Make at least the minimum on time every month. Setting up autopay can help. Pay extra when possible to pay down principal faster.
Credit limits – Having available credit left on the loan helps your utilization ratio. Avoid running up your balance.
Mix with other credit accounts – Use the loan strategically along with varied credit cards, auto loans, or mortgages.
Following these best practices will help ensure your personal loan aids your credit building mission.
Be Aware of Potential Credit Risks
While personal loans can build credit, there are also risks to consider:
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Taking on more debt than you can handle could lead to missed payments and credit damage if a financial emergency arises.
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High origination fees on some personal loans diminish how much cash you get upfront.
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Applying for too many loans in a short timeframe can negatively impact your credit score.
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If not used strategically, the benefits to your credit profile may be minimal or temporary.
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Defaulting on the loan would severely hurt your score and credit standing.
To maximize benefits while minimizing risks, have a plan for how you’ll use the funds responsibly. And explore alternatives if your financial situation makes repayment uncertain.
Other Options to Build Credit from Scratch
Personal loans aren’t the only path for establishing or rebuilding credit. Some alternatives to consider are:
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Secured credit cards – These require a refundable security deposit that becomes your credit limit. You can’t overspend, limiting risk.
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Co-signer – Asking someone with good credit to co-sign makes it easier to qualify while you build history.
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Credit-builder loans – Similar to personal loans, but the lender deposits monthly payments into a savings account you get back if all payments are made.
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Retail credit cards – Store-specific cards tend to have lower credit requirements but high interest, so use carefully.
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Authorized user status – Getting added as an authorized user to a spouse or parent’s credit card provides credit history help.
Weigh the pros and cons of each method to decide which aligns best with your credit situation and needs.
Tips for Using Personal Loans to Build Credit Effectively
If you determine a personal loan is your best credit-building option, employ these tips for success:
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Compare loan providers to get the lowest interest rate for which you qualify. Avoid predatory lenders.
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Understand the fees involved so they don’t eat up your available credit.
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Only borrow as much as you know you can pay back based on your budget.
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Make payments on time every month to boost your payment history. Set up autopay if it helps.
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Pay down the principal aggressively when possible to keep credit utilization low.
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Have a plan for how you’ll use the loan proceeds wisely and responsibly.
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Monitor your credit using free services to see your score improve as you build history with the loan.
Using personal loans strategically demonstrates responsible borrowing and can be a launchpad for establishing strong credit. Just be cautious, have a repayment plan, and use other positive credit habits. Soon you’ll graduate from credit-building and qualify for top-tier rewards credit cards and loans earmarked for borrowers with excellent credit.
Leverage Personal Loans as a Credit Booster
Now that you understand the smart ways personal loans can build credit, as well as potential risks, you can make an informed choice about whether a personal loan has a place in your credit-building toolkit. Used strategically and managed diligently, a personal loan can provide the credit history boost you need to reach your financial goals. Be sure to compare multiple lenders to find affordable loan terms so the benefits outweigh the costs. With your new credit-building knowledge, it’s time to put your plan into action!
Bad-credit and no-credit personal loans are expensive
Having less-than-stellar credit may not stop you from getting approved with certain lenders, but there’s usually a price to pay when you’re considered a higher-risk borrower. Some personal loans come with an annual percentage rate of more than 30%, while fees associated with payday loans translate to triple-digit APRs.
APRs can include both interest and fees, so it’s important to read the fine print to know what you’re paying.
How you can use a personal loan to build credit
A personal loan may help with most of the five factors that influence your credit scores.
- Payment history: Getting a loan and making all of your monthly payments on time establishes a track record of regular activity. This is a primary factor in building a positive credit profile.
- Credit usage: How much debt you have — and what kind — is a reflection of how well you manage credit. 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. If you’ve never used credit, getting a personal loan can help you start this process.
- Credit mix and types: If your credit history is limited, having varying types of credit, like credit cards, personal loans and mortgages, can help boost your credit scores.
The fifth factor that can influence your credit profile is recent credit. When you apply for a personal loan — or any type of new credit for that matter — the lender may run a hard inquiry on your credit reports to check your credit history. This can lower your scores by a few points. That said, a single inquiry typically won’t influence your scores significantly, and they can often recover within a few months.
Credit Builder Loans Full Guide – How Does It Work, Pros & Cons
FAQ
Will a personal loan raise my credit score?
How fast does a loan build credit?
Are personal loans considered credit?
Do personal loans show up on credit check?
Can a personal loan build credit?
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. 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.
Does a personal loan affect your credit score?
Late payments can significantly damage your score if they’re reported to the credit bureaus . In addition, taking out a personal loan will increase the amount of debt you owe, which is one of the factors
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.