Will Taking Out a Loan Build Your Credit? What You Need to Know

Taking out a personal loan is often seen as a quick way to get access to cash But did you know that it can also help build your credit?

Your credit score plays a big role in your financial life It impacts everything from whether you can get approved for new credit cards and loans to how much interest you’ll pay, Having good credit saves you money over your lifetime

So how exactly can a personal loan build your credit? And how should you use loans to improve your credit score? This guide will explain everything you need to know.

How Personal Loans Can Build Your Credit

Personal loans allow you to borrow a lump sum of cash upfront and pay it back in fixed monthly payments over a set repayment term. They can be secured or unsecured.

With an unsecured personal loan, you don’t put up any collateral. The lender bases its decision purely on your creditworthiness.

Secured loans require collateral like your house or car. The lender can seize the collateral if you default. Since there’s less risk, secured loans often have better terms.

Now you might think that taking on debt would hurt your credit, not help it. But when used responsibly, personal loans offer several credit-building benefits:

1. They Can Establish a Payment History

Payment history makes up 35% of your FICO credit score. It measures your track record of repaying debts on time.

Each month that you make your personal loan payment on time, you build up your payment history. This shows lenders that you’re reliable.

Just one 30+ day late payment can lower your credit score by 90-110 points. So it’s vital to never miss or be late on a payment.

If you do have trouble making a payment, ask your lender about hardship programs or deferments. This preserves your payment history.

2. They Demonstrate How You Handle Debt

Lenders want to see that you can responsibly manage different types of credit. Taking out a personal loan shows them that you can handle installment loan debt.

Having a mix of credittypes also helps your score. Credit mix makes up 10% of your FICO score. Personal loans add to your mix along with credit cards, mortgages, student loans, etc.

Just don’t take on more debt than you can afford. Too many new accounts at once hurts your score. Space out applications over time.

3. They Can Lower Your Credit Utilization

This refers to how much of your available credit you’re using across all accounts. Owing $3,000 on a $10,000 limit is 30% utilization.

Lower utilization is better for your score. Experts recommend keeping it below 30%. The lower, the better.

Utilization makes up 30% of your FICO score. By paying off balances with a personal loan, you lower your overall utilization.

Just don’t keep the accounts open or run balances back up. This defeats the purpose. Close or refrain from using maxed out accounts.

4. They Expand Your Credit History Length

FICO looks at the average age of your credit accounts. Older accounts signal more experience, raising your score.

Each new account lowers your average age, but a personal loan adds to your overall history length. And the longer you hold it, the more it ages and helps.

15% of your FICO score is based on history length. Even a short-term loan helps if you keep it for the duration and don’t open other new accounts.

Do’s and Don’ts of Using Personal Loans to Build Credit

Now that you know why personal loans can build your credit, let’s look at some dos and don’ts for using them effectively:

Do:

• Shop around for the best rate: Compare loan offers from multiple lenders. A lower rate saves money.

• Read the loan terms closely: Check for prepayment penalties or clauses that could alter the rate.

• Make payments on time: Set up autopay through your bank. A single late payment can devastate your score.

• Pay down balances before applying: Lower utilization boosts approval odds and can secure better terms.

• Ask about credit reporting: Ensure the lender reports your payments to at least one bureau.

Don’t:

• Apply for too many loans at once: Each application causes hard inquiries that can lower your score.

• Borrow more than you need: Only take what you must to keep payments manageable and your debt low.

• Open other new accounts: This reduces the positive effects on your history length and utilization.

• Use the loan for non-essential purchases: Frivolous spending won’t help your financial situation or credit.

• Take on more debt as your score rises: More accounts or higher balances outweigh score improvements.

What Credit Score Do You Need to Get Approved?

The minimum credit score needed for a personal loan approval depends on the lender. Here are some general approval guidelines:

• Excellent credit (720+): Offers the lowest rates and best terms. More lenders will approve you.

• Good credit (680-719): Still qualifies for competitive rates from most lenders.

• Fair credit (640-679): Approval is possible but expect higher rates and more fees.

• Poor credit (639 or below): Very few lenders will approve. Try a credit-builder loan to boost your score first.

Each lender has its own underwriting standards. Having income, low debt-to-income ratio, and other positive factors can sometimes offset a lower score.

Those with no credit history will have the most difficulty getting approved. You may need to open a secured credit card or become an authorized user first.

Alternatives for Building Credit Without a Loan

Taking out a personal loan isn’t the only way to build credit. Some alternatives worth considering include:

• Secured credit cards: These require a refundable security deposit and help establish credit history.

• Credit-builder loans: The lender deposits the loan amount into an account and releases funds once repaid.

• Authorized user status: Get added to a family member’s account. Their payment history can start to benefit you.

• Reporting rent: Experian Boost lets you add positive rent payments to your credit file.

• Becoming an account holder: Ask to have utility bills or other regular expenses put in your name.

• DIY credit repair: Dispute any errors on your reports to boost your score quickly.

Evaluate your options carefully and choose the ones that fit your needs and financial situation best. Taking the right steps now means reaping the rewards of better credit.

12 Tips for Building Credit Fast

Looking to give your credit score a quick boost? Here are 12 effective strategies:

1. Correct errors on your credit reports – Errors drag down your score. Dispute them with the bureaus to fix your credit faster.

2. Lower credit utilization – Pay down balances to reduce your overall utilization. Below 30% is ideal.

3. Become an authorized user – Get added to a family member’s credit card responsibly. Their history boosts your score.

4. Avoid closing old accounts – Keep your longest open cards and loans open to preserve your age of credit.

5. Mix up your credit types – Apply for new credit sparingly and wisely to add installments, revolving, and other accounts.

6. Limit hard inquiries – Too many applications in a short time can lower your score temporarily. Only apply for what you need.

7. Review all account terms – Understand grace periods, fees, APRs, etc. to avoid score-damaging surprises.

8. Create payment reminders – Set up alerts to avoid ever missing payments and damaging your history. Autopay helps too.

9. Keep credit card balances low – High balances relative to your limits tank your utilization and credit.

10. Build savings – Financial cushions prevent you from missing payments and allow you to pay down debts faster.

11. Stick to a budget – Monitor your spending and avoid unnecessary debts. Live below your means.

12. Be patient – Building credit takes diligence and time. Stay focused on long-term score goals.

The most important thing is developing smart credit habits. With time and discipline, you’ll start to see your credit transform.

The Takeaway

Getting a personal loan can build and improve your credit in several key ways. But you need to use it strategically and responsibly.

Set a goal for where you want your credit score to be. Then make a plan to get there using the information in this guide.

Building strong credit now makes it easier to secure loans, credit cards, mortgages, and other products in the future on better terms. You’ll save thousands over a lifetime with a top credit score.

Just remember, improving your credit hinges on adopting good financial habits. Make payments on time, keep debt low, and use credit wisely. With time and commitment, you’ll be on your