How to Use Personal Loans to Rebuild Credit
As long as you make on-time payments in full, you can use a personal loan to build credit. Notably, if you have bad credit or don’t have consistent earnings, you might end up with high interest rates. 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. You’ll borrow a fixed amount of money from a lender, which you’ll then pay back in intervals over the course of the loan term, with interest.
When you make on-time payments, and they’re recorded on your credit reports, it can help boost your credit score. On the other hand, missed payments can cause your credit score to drop by as many as 180 points. Be sure to keep up with payments, or you could hurt your credit score.
How to use a personal loan to build credit
A personal loan can demonstrate your ability to manage debt. Here’s how lenders may view your decision to take out and fully repay a personal loan:
- Build up a payment history. A lender wants to know that you’ll repay any money you borrow. Demonstrating a consistent repayment history using a personal loan can show future lenders that you’re a reliable borrower. Your payment history makes up 35% of your FICO credit score, so be sure to keep up with what you owe each month.
- Responsibly manage your credit. Lenders evaluate you based on how you use your credit — how much debt you take out, what type of debt you have and your repayment history. A personal loan can help demonstrate this as long as you don’t borrow too much and can keep up with payments.
- Improve your credit mix. Your credit mix accounts for 10% of your FICO Score. Having multiple types of credit accounts can help your rating. If you have little variety in your credit history, taking out a personal loan could provide a boost to your credit score.
- Lengthen your credit history. The length of your credit history makes up 15% of your FICO Score. If you have little to no credit history, lenders may be more cautious about offering you money. A personal loan can extend your history as a borrower and boost your score.
Drawbacks of using a personal loan to build credit
Using a personal loan to rebuild credit won’t be the right solution for everyone. Consider potential downsides before you make a commitment.
- Hard credit pulls can impact your score. When you take out — or apply for — a personal loan, your lender will run a hard credit pull to check your credit background. This’ll cause your credit score to drop up to five points, and the inquiry stays on your credit report for up to two years.
- APRs can be expensive. If you have bad credit or very little experience with credit, your annual percentage rate (APR) will be higher than someone with good credit and a long credit history. APRs can be as high as 36% for personal loans.
- Late payments can bring down credit. If you’re not able to keep up with payments, it can have a devastating impact on your credit score. It can also make it difficult to take out future loans.
- Lender may not report to the credit bureaus. Before you sign with a lender, make sure your lender reports to at least one of the major credit bureaus. The bureaus record your activity on your credit reports, which then informs your credit score. If a lender doesn’t report your payments, it won’t improve your credit score.
Alternative methods to build credit
If a personal loan wouldn’t be a good option for you, consider instead one of these other options, which can also help you build credit:
- Credit builder loans are a unique type of installment loan that does exactly as its name suggests — helps build your credit. If you’re new to credit or have poor credit, a credit builder loan may be easier to qualify for than a personal loan. When you take out a credit builder loan, instead of the lender giving you the funds, it keeps the money in a special savings account that you can access once you pay it off.
- Credit cards differ from personal loans since, instead of receiving a lump sum of money, you’ll have access to a line of credit up to a predetermined amount. With a credit card, you’ll only pay interest if you carry a balance. If you pay your credit card bill in full each month, you won’t have to pay any interest. If you don’t have great credit, you can also apply for a secured credit card or become an authorized user on a loved one’s account.
- Report regular bills to the credit bureaus instead of taking out a loan. For instance, you can report rent payments to the credit bureaus which can help boost your credit score. You can also report your utility bills.