How To Boost Your Credit Score With A Personal Loan

The main points

Making payments on time can help you improve your credit score faster.

Debt consolidation loans and credit building loans are two personal loans that can be used to reduce your total debt and build your score.

There are a number of risks associated with using personal loan to build credit, such as excessive borrowing and potential credit damage through missed payments.

When you repay personal loans consistently, you can boost and maintain your credit score by building a positive payment history and diversifying your credit mix.

While this may work for some, keep in mind that it is not the best option for everyone. Those with a steady, stable and predictable income and a good credit score are the ones who can benefit the most from this method of building credit.

Why a personal loan may help you build credit

Your credit score is one of the most important indicators of financial well-being. Lenders and banks often rate credit on factors such as employment history or education, as it serves as an indicator of risk. The lower your credit score, the less likely it is that you will be approved for a loan or qualify for a competitive interest rate.

Your payment history makes up the largest percentage of your FICO credit score -- 35 percent overall. However, making monthly payments on time and in full is a sure way to increase your score over time.

How to increase your credit score with personal loans

You may utilize a personal loan to improve your credit score in a variety of ways. The most popular options are debt consolidation loans and credit building loans.

Debt consolidation loan

As the name suggests, these loans are personal loans used for debt consolidation. Let's say you have three credit cards, each with outstanding balances and relatively high interest rates. Consolidating this debt will allow you to borrow the amount required to pay off all three cards under a new loan with one fixed monthly payment.

This can help your credit in several ways. First, if you pay off the balances on your credit cards, you'll lower your credit utilization ratio -- the amount of available revolving credit you use. It can also improve your credit mix because credit scoring forms like to look at different types of revolving debt, like credit cards and installment loans, like personal loans.

However, consolidating your debt only makes sense if you are offered a lower interest rate on your new loan than on your previous loans. Otherwise, you will end up paying more interest charges over the life of the loan.

Who is it best for: Debt consolidation loans are ideal for individuals who qualify for better interest rates and want to consolidate the balance on higher interest credit cards to simplify the payment process.

Credit builder loans

A credit building loan requires you to make fixed monthly payments over a set period of time. Unlike traditional personal loans, you will not be able to access the funds until the loan is paid off in full with interest.

You can use the funds as you wish once they have been released to you. Some borrowers choose to raise their emergency fund. Others use the money to pay off small debts or achieve other short-term financial goals.

To some, credit building loans may seem inconsequential, as you cannot access the money borrowed until you have paid it off. However, you will create a history of timely payments, which will increase your score over time.

Remember that a credit builder loan isn't for everyone, especially if you need the money before paying off the sum. Additionally, you may have to pay an opening fee for the loan, and depending on your credit, the rate of interest that is offered may feed into the total cost of the loan.

Who is it best for: Credit builder loans are best for individuals who do not have a credit history or who do not need immediate access to funds.

The risks of using personal loans to build credit

Before taking out a credit-building personal loan, make an informed decision by considering the risk factors that will benefit you now and in the future.

Serious inquiry about your credit report

Whenever you apply for a personal loan, you will get what is known as a hard inquiry on your credit report. More difficult inquiries will drop your score a few points, but it is usually easier to rebuild your score with a good pay history.

While one inquiry at a time can be managed and even anticipated by lenders, multiple inquiries in a short period of time will greatly lower your score and is considered a risk factor by lenders. can be understood as

Getting a loan

Any debt you take on is more debt you take on. Remember that you should not take out a loan if the debt is causing you financial hardship, even when using a personal loan to help pay off debt and lower interest rates.

Associated fees

Depending on the lender, the loan you're applying for will likely have at least one fee. Although it may appear to be a little expenditure in comparison to the entire sum, several fees can add up and reduce the overall cost of your loan.

Before signing on the dotted line, read the terms and conditions to find out the fees associated with any loan. If the lender you're looking for charges multiple fees, it's best to look elsewhere. Some companies boast that they charge very low fees, and a handful of lenders charge no fees at all.

Alternative ways to build credit

If a personal loan isn't the best way to build up your credit, there are alternatives that -- when used responsibly -- can help increase your score over time.

A secured credit card

A secured credit card uses the money you have in a designated account to act as collateral against the card's credit line. Lenders are generally more lenient with secured cards and are more likely to serve borrowers with bad credit history because they take less risk because of the collateral.

The credit limit of a secured card often depends on the size of your security deposit. This means that you will have access to a lower balance than with a traditional card. However, a secured card can still be a great way to increase your score as long as you pay on schedule.

The main drawback to a secured card, and any product that requires collateral, is that if you default on the balance, your collateral can be legally forfeited to cover missed payments. Before committing to a card, make sure that any resulting monthly payments fit snugly into your future financial plans.

Joint account

Co-signing a loan or becoming an authorized user on a credit card can help build your credit because when you co-sign, you take full responsibility for the loan. If you and the other account holder make your monthly payments on time and in full, you can take advantage of the credit's benefits.

But if the person you partnered with misses or defaults on the loan, the consequences are twofold. Not only will this harm your credit rating, but you will also be legally responsible for making up missed payments.

Reported alternative payments

Some service providers may be willing to report account activity to the credit bureaus upon request. Consider reaching out to your cell phone, utility, and cable providers and asking if they will report payments on your behalf to the three major credit reporting agencies—Experian, TransUnion, and Equifax. You can also ask the landlord to report rent payments.

Bottom Line

Personal loans can help you build credit if you use it to consolidate debt or build a timely payment history. If you choose to use a personal loan to build credit, remember to be aware of the risks involved and compare quotes from several lenders to make sure you get the cheapest loan that suits your situation.