If you’re just starting out on your financial journey or are recovering from a financial setback, a poor credit score can make it difficult to borrow the money you may need to pay for education, a car, or other important things you need to get ahead in life.
While borrowing money to improve your ability to borrow money might sound like a bad idea, taking out a personal loan and paying it back on schedule is an effective way to prove your ability to manage money responsibly. Credit bureaus will take note — and will adjust your credit score accordingly.
So, will a personal loan build credit? We’ll answer this question, explore the pros and cons, as well as uncover the advantages and disadvantages of some alternatives. We’ll also consider smart tips for managing your loan to ensure you get the most benefit for your credit score.
Personal loans offer access to money at a fixed interest rate and generally at a lower rate than a credit card or revolving line of credit. Most personal loans are also unsecured, meaning you are not required to put up collateral in the form of a personal asset such as property or vehicle in order to secure the loan.
With set monthly rates and a predetermined payoff date, personal loans offer a predictable, affordable, and easy-to-manage way to borrow money. If poor personal credit is making it difficult for you to access credit for a car purchase, college loan, or mortgage, taking out a personal loan to pay for smaller expenses can be a stepping stone to more affordable borrowing in the future.
Whether you choose to use your personal loan to pay down existing credit card debt or other high-interest loans, or to fund other necessary expenses, you’ll soon find making regular, on-time payments in full benefits your credit score in several key ways:
Each on-time payment you make is reported to the credit bureaus, improving your credit score. In fact, payment history is the single largest factor influencing your creditworthiness in scoring models used by most bureaus, making up 35% of your score.
That means steady, on-time payments will have an immediate and measurable impact on your score from the first repayment you make.
If you already have other forms of debt, including credit cards, store credit or a revolving line of credit, a personal loan can help improve your credit mix. Lenders like to see an ability to manage more than one type of borrowing simultaneously, so credit bureaus reward the ability to pay off multiple loans simultaneously.
Credit bureaus also track how much of your available credit you choose to utilize at a given time.
For example, typically, using more than 30% of your total credit limit on cards or lines of credit will begin to weigh on your credit score. Using a personal loan to pay down your credit card balance or other “lines” of credit effectively reduces your credit utilization rate.
Taking on a personal loan is a serious commitment to pay off what you borrow within a defined period. In addition to improving your credit score over time, it shows a willingness to take charge of debt that lenders will take note of when they review your full credit history.
Is taking out a personal loan to help improve your credit score the right move for you? Let’s take a look at the major advantages plus some potential disadvantages of this strategy.
Major advantages of using a personal loan to improve your credit include:
That said, there are some drawbacks to improving your credit in this way.
There are several alternatives to using a personal loan to improve your credit, each with its strengths and weaknesses.
A credit card can be a good way to build credit while taking advantage of an easy and convenient way to manage day-to-day expenses and larger purchases. You’ll build credit in much the same way as a personal loan provided you keep your balance low and make payments on time.
Credit cards are best for disciplined, organized spenders who will not be tempted to accumulate a large balance by overspending or making only minimum repayments.
Opening and running a joint checking account with a spouse, partner, or trusted friend can provide an alternative or additional source of payment information for those looking to boost their credit score. By sharing resources to ensure you pay bills and utilities on time, you can both rack up credit-boosting payment data on multiple accounts.
While this is a potentially powerful tool for organized couples, you need to have a partner or friend who you can trust and rely on to contribute funds and make payments on time.
For those just beginning their financial journey or recovering from bankruptcy or another financial setback, many banks and lenders offer special credit-building loans and credit cards designed especially to help boost creditworthiness.
Credit-building loans and credit cards usually work by requiring you to deposit an amount that you then borrow to build credit over time. In effect, you are lending and repaying yourself your own money, but you demonstrate an ability to make payments on time and manage debt that improves your credit score over time.
Using a personal loan to boost your credit score is all about demonstrating your ability to be organized and responsible. Here are four key tips for getting the most credit-building power out of your loan.
Check your credit regularly so you can see how your payments are affecting your score. You can track improvements and gain valuable inspiration! Sign up for credit score updates from FICO or any of the big three credit reporting bureaus: Experian, TransUnion, and Equifax.
Better credit is all about on-time payments. Make sure you never miss a payment by setting up an automatic debit payment from your checking account.
Once you have your loan, stay focused on building credit. Avoid the temptation to take out new credit that will ping your score for each new account and could negatively affect your credit mix.
Some credit bureaus let you link your credit report to your bank or credit card and reward regular payments on rent, utilities, and other bills with improved scores. It’s a good way to make sure you’re getting full credit for all your hard work and organization.
Signing up for a personal loan to help improve your credit score can be a smart move, especially if you already have existing credit card debt or if you would benefit from a structured, predictable payment plan.
On the other hand, it might not be the best option if you do not have steady employment or are not comfortable committing to a fixed, long-term installment payment plan.
At Foothill Credit Union, we offer flexible, convenient personal loans to our members to help consolidate debt, improve credit, or manage unexpected or unavoidable expenses.
With a Foothill CU personal loan, you can:
Talk to us about whether a Foothill CU personal loan is right for you. Contact our helpful staff today, or click below to learn more about the benefits of your personal loan products.
