Find Out the Facts: Do Personal Loans Build Credit?

Building good credit is one of the things we need to do to have access to good loan terms and rates. Good credit signals potential lenders and creditors as to our creditworthiness. But what exactly does it take to build good credit? Do personal loans build credit, and are there loans to help improve credit if it’s not where we want it to be? The answer is yes; personal loans are great for building credit if you know the right strategies.

Highlights & Key Takeaways

• Personal loans do help you build credit.
• Paying on time every month is the most important thing you can do to build a good credit history and a good or excellent credit score.
• Be mindful when taking out a personal loan - credit bureaus frown upon borrowers that apply for or try to take out too many loans.
• Every time you apply for a personal loan, it will result in a hard credit check, which can ding your score by up to ten points.

How to Use a Personal Loan to Build Credit

A low credit score, more commonly referred to as a poor or fair credit score, sits at 669 or below on the FICO scoring scale. On the other hand, good credit is a score of 670 or higher. A good credit score can help you secure a lease on an apartment, get lower interest rates on credit cards, and more. And thankfully, a personal loan can help you build credit to get you a good or excellent credit score. Here’s how to do it:

• Pay your personal loan on time every month and make at least the minimum monthly payment.
• Having a personal loan, in general, helps you to build your credit history, especially if you pay it on time each month.
• A debt consolidation loan, a type of personal loan, can help you save money by consolidating your high-interest credit cards into a lower-interest loan product - this inevitably makes it easier for you to pay your monthly bill on time. 
• Credit-builder loans, though they don’t give you immediate access to funds, are an excellent way to help you establish a history of on-time payments, which lenders will report positively to the credit bureaus.
• Secured loans require collateral and are an acceptable way to build a good credit history.

As you can see, personal loans are a great way to build good credit, provided you are responsible with your payments. And this is a good thing because on-time payments represent 35% of your credit score. This said, using a personal loan to build credit is not a quick fix. Building an initial credit history generally takes at least six months, but building good credit can take even longer. 

“Using a personal loan to build credit is not a quick fix. It can take six months to establish a credit score and even longer to build a good credit score. Establish a good credit history by making your payments on time, keeping your debt-to-income ratio under 48%, and don’t apply for more loans than you need.”

How Long Does it Take to Build Credit with a Personal Loan?

Establishing a credit score upfront can take at least six months. During that time, it is integral that you make your payments on time every month. But even though you can build a credit score from scratch, it can take longer to build a good credit score. If you already have established credit, take the time to review your credit report for inaccuracies, ensure you have a healthy mix of credit, and that you are not over-utilized on your credit cards.

How a Personal Loan Can Hurt Your Credit

Conversely, just as personal loans build good credit, they can hurt your credit too. So before you take out a personal loan, be thoughtful to ensure it is the right strategy for you and that you can take on the responsibilities that come with the loan. When you apply for a personal loan, the following will happen:

• A hard credit check will be made on your credit. If you have applied for multiple loans in a short period of time, this doesn’t look good to the credit bureaus, and your credit score will take a hit.
• A personal loan is good for building credit, but it means you are taking on more debt, so your debt-to-income ratio will increase. So, limit spending habits that add more debt while paying off your new personal loan.
• Most personal loans come with fees. Read the fine print to understand any origination fees along with your APR (annual percentage rate) and late fees should you miss a payment (do your best to make your minimum payments on time every month).

“Using a personal loan responsibly is a great way to build your credit. It helps you establish a credit history and provides you the opportunity to develop good payment habits. However, when taking out a personal loan, be mindful of your debt-to-income ratio and your credit mix. Too many personal loans or too many credit cards are not a good thing.”

Other Methods of Building Credit Besides Using a Personal Loan

Though using a personal loan to build credit is often a great strategy, sometimes it isn’t an option. But the better news is that there are plenty of other options. Check out these other strategies to help you improve your creditworthiness.

• Get a secured credit card - Secured credit cards work much like traditional credit cards, but borrowers must pay a cash deposit to guarantee their credit line. This might seem counter-intuitive, however, because you have to give the creditor money for them to borrow your money back. But this is a great way to build a good payment history.
• Try a credit-builder loan - A credit-builder loan is an installment loan that works like a secured credit card. The money from your loan goes into a savings account or certificate of deposit (CD), and you get the money back after you’ve made all your payments. Again, this is a great way to build a good payment history.
• Become an authorized user on someone else’s credit card - This is a great opportunity to piggyback off someone else’s account. However, ensure that the cardholder has good credit standing, or this plan might work against you.
• Consider credit counseling services. Credit counselors advise you on your money and debts, help you with a budget, and offer money management workshops.
• Be responsible with an auto loan. Your credit mix is 10% of your overall credit score. The bureaus like to see that you can responsibly manage more than one type of credit. So, make sure you are paying those auto bills on time.

What is The Right Personal Loan To Build Credit

As we’ve alluded, getting a personal loan can benefit your credit score. But the trick is finding the right personal loan to achieve your goals. Here are the types of personal loans for you to consider:

• Debt consolidation loan - These loans do just what they say they will. They allow you to combine other loans or credit cards that may have higher interest rates. The result is a lower monthly payment and less interest paid over time.
• Emergency loan - Though emergency loans are often best considered as a last resort because they are commonly associated with high-interest rates, they are a good option if you have a sub-optimal credit score but need funds fast. Emergency loans are good for emergency medical expenses, home repairs, etc.
• Installment loan - These loans let you borrow a lump sum and pay it back in monthly payments you agree to ahead of time. An installment loan is good if you want to consolidate debt or finance a large purchase.
• Home improvement loan - Just as these loans imply, they are perfect if you want to add landscaping, build a deck, finish your basement, add on to your home, etc. Many lenders offer high borrowing amounts, flexible terms, and low-interest rates for home improvement loans.

Other Loans That Can Help You Build Credit

• Student loans
• Auto loans
• Credit-builder loans
• Mortgages
• Payday alternative loans (PALs)
• Home equity loans

Common Misconceptions About Personal Loans and Credit Scores

• Do personal loans always hurt your credit score?
• Are personal loans only for people with bad credit?
• Can you only get a personal loan from a bank?
• Do personal loans have higher interest rates than credit cards?
• Can you only use a personal loan for debt consolidation?

Benefits of a Good Credit Score

Having a good credit score does more than just make you feel good. In fact, the better your credit score, the more benefits you will experience. A good credit score can open up the following doors for you.

• Higher credit limits
• Lower interest rates
• More purchasing power via prequalifications or preapprovals

And keep in mind that with a good credit score, you’ll get access to those higher credit limits, lower interest rates, and more purchasing power. But as your score increases, especially if you have an excellent score, those credit limits can continue to increase, and those interest rates can continue to drop.

Final Word

All in all, having a good credit score is good. And, if you want to improve your credit score, personal loans do help you build your credit. But as with any financial decision, be sure you don’t bite off more than you chew. Be cautious about how much debt you take on, and don’t take on a personal loan unless you are confident that you can make your minimum payment on time every month. 

The final word is to be responsible with your personal loan, and your credit score will be better for it.