How to use a personal loan to build credit

Having a good credit score is essential to getting credit from banks and financial institutions. However, building a healthy credit score requires a spotless credit history, which may not always be feasible. Read on to find out how loans can help.

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Obtaining a loan and making all of your regular payments on time establishes a responsible track record. This is a key factor in establishing a positive credit profile.

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If you have dents and scratches on your credit report, it may take time and planning to improve your credit rating. Taking out a personal loan is one way to improve your score.

Credit-builder loans can help people with no or limited credit history improve their credit scores and increase their savings.

Why use a personal loan?

You must first understand how the credit scoring system works to improve your credit score. Equifax, Experian, and TransUnion are the three major credit scoring bureaus that provide credit scores. 

According to Experian, the average credit score is 711, but younger generations have credit scores below 700. Your credit score will influence everything from the interest rate on loan to whether you’ll be approved for an apartment. So building good credit is essential.

Banks, lending institutions, and other authorities may investigate your credit history to determine whether you are a trustworthy person to lend to.

A credit builder loan is especially beneficial to:

  • People looking for a new credit line
  • People who don’t have a credit history and credit score
  • People who want to pay off their existing loans
  • People looking to improve their credit history and credit score 

How does a credit-builder loan work?

Credit scores are calculated using five criteria. Each carries a different weight: payment history (35%), credit utilization (30%), length of credit history (15%) and credit mix (10%) and new credit (10%)

If your credit-builder loan application is approved, here’s how a personal loan can improve your credit score:

  • Reduces your credit utilization ratio: If you are taking a personal loan to consolidate your credit card debt, you can reduce the utilization of your credit card(s). The personal loan will be utilized to pay off your credit card balances, resulting in more unused credit. The amount and type of debt you have reflects how well you manage credit. A personal loan can totally help with this, as long as you pay it back on time and don’t accumulate too much other debt.
  • Payment history: Obtaining a loan and making all of your regular payments on time establishes a responsible track record. This is a key factor in establishing a positive credit profile.
  • Diversifies your credit mix: Having a mix of credit products, such as loans and credit cards, and managing them responsibly shows lenders that you can handle a variety of credit products.
  • Your lenders must report to the credit bureaus: Every month, your lender must report the details of your payments, including whether they are on time, to at least one of the three major credit bureaus. When you make regular and timely payments on a personal loan, the three major credit bureaus are notified.

Do’s and don’ts

Make payments on time: If you repay the loan on time, you will accumulate positive information on your credit reports. A payment that is over 30 days late will appear on your reports and can seriously harm your credit score.

Don’t go overboard applying for loans: Applying with multiple lenders at the same time could affect your chances of approval.

Continue to use and pay off your credit cards in full each month: If you use a personal loan to pay off high-interest credit card debt, you must report activity from both your cards and your loan in order to continue building your credit score.

Only borrow what you need: Borrow only what is absolutely necessary to achieve your objectives. A smaller loan will make payments more manageable and increase your chances of paying them off on time.

Do the research and compare lenders: Before applying for a loan, look for a credit-builder loan with a payment and term that you can comfortably handle.

Don’t just apply for a loan with the first lender you see: Interest rates and fees can vary greatly between lenders, so shop around and compare offers from multiple personal loan lenders to ensure you get the best rates and repayment terms.

This page is purely informational. Line does not provide financial, legal or accounting advice. This article has been prepared for informational purposes only. It is not intended to provide financial, legal or accounting advice and should not be relied on for the same. Please consult your own financial, legal and accounting advisors before engaging in any transactions.

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