How to improve your credit score with a personal loan

Credit scores are a daily factor in our lives, whether we realize it or not. The better your credit score, the more credit you have at your disposal and the less interest you will have to pay. If you have bad credit, it will be harder for you to access affordable credit.

One way to improve your credit health is to take out a personal loan. If used responsibly, a personal loan could help you pay off debt or establish a good payment history, which could improve your credit score. But if lenders aren’t willing to approve you for a personal loan on favorable terms, there are other viable alternatives to consider.

Get pre-qualified

Answer a few questions to see which personal loans you are pre-qualified for. The process is quick and easy, and it won’t affect your credit score.

Ways to Boost Your Credit Score With a Personal Loan

You can use a personal loan to build your credit rating in several ways. The most popular options are usually debt consolidation loans and credit enhancement loans.

debt consolidation loan

As their name suggests, these loans are personal loans used to consolidate debts.

Imagine you have three credit cards, each with an outstanding balance. You make three payments each month at three interest rates. A debt consolidation loan lets you borrow the money to pay off all three cards, and you’ll repay that loan with one payment per month, often while saving money in the process due to lower rates. of interest.

This can help your credit in several ways. On the one hand, if you pay down your credit card balances, you lower your credit utilization rate – a determining factor in your credit score. You can also improve your credit mix, as credit scoring models like to see a variety of revolving debt, like credit cards, and installment loans, like personal loans.

Who is it best for: Debt consolidation loans are ideal for people who want to consolidate their high-interest credit card balances into a loan product with a more competitive rate to save money and streamline the repayment process.

Credit builder loan

A credit-builder loan is a loan product that requires you to make fixed monthly payments over a set period of time. Unlike traditional personal loans, you won’t have access to the funds until the loan has been repaid in full with interest.

Once the funds are disbursed to you, you can use them as you see fit. Some borrowers choose to increase their emergency fund. Others use the funds to pay off small debts or meet other short-term financial goals.

These credit-building loans may seem counter-intuitive because you only have access to the borrowed money after you pay it back. Nevertheless, you will establish a timely payment history, which the lender will then report to the credit bureaus. At this point, the money is yours unconditionally, fully refunded. It’s like putting money in a savings account, but with the benefit of increased credit.

Keep in mind that a credit enhancement loan is not for everyone. You may have to pay a fee to open the loan, and you’ll need to factor any interest into the amount you pay each month.

Who is it best for: Credit building loans are best for people with bad credit or no credit history who want to save money while building their credit.

Risks of Using Personal Loans to Build Credit

Although personal loans can be helpful in improving your credit rating, there are also some risks. Before getting a loan to build credit, think carefully about these risk factors and make sure that taking out a loan is the right choice for you.

Serious investigation of your credit file

Each time you apply for a personal loan, you get what is called a “thorough investigation” of your credit report. Your credit score could drop, but the impact usually won’t last more than a few months. While one of them is manageable, it can become detrimental if you shop around for loans and end up with multiple tough inquiries on your credit report.

Get into debt

Any loan you take out is debt you take out. Remember that you should not take out a loan if the debt is causing financial hardship. Even when using your personal loan to pay off debt and reduce interest rates, it is essential that you limit any spending behavior that would increase debt while you are paying off your personal loan.

Associated costs

There’s more to pay on a personal loan than the amount you borrowed in interest. Fees are associated with almost all available loans. Although they are a minor cost compared to the loan itself, you don’t want to be blindsided by these fees. Be sure to read the fine print to find out what fees are associated with any loan before signing on the dotted line.

Alternative ways to build credit

A personal loan isn’t the only way to improve your credit score. Consider the benefits and risks of alternatives, like secured credit cards and joint accounts.

Secure credit card

A secured credit card is a special type of credit card that uses money you have set aside in a specific account to act as collateral against the line of credit you have on the secured card. The credit limit of a secured card is mainly based on the amount of the security deposit you make when applying for the card. Because you could lose your collateral if you miss payments, lenders are more likely to extend this type of credit card to people with bad or no credit. Making regular payments, however, could boost your score.

Joint account

Co-signing a loan or becoming an authorized credit card user can help you build your credit because when you co-sign, you share full responsibility for the loan. If you and the other account holder make monthly payments, you can both receive credit benefits.

Keep in mind that if the person you’re co-signing for misses payments or defaults on the loan, not only will it hurt your credit rating, but you’ll be legally responsible for making up lost payments.

Alternative payments reported

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

Get pre-qualified

Answer a few questions to see which personal loans you are pre-qualified for. The process is quick and easy, and it won’t affect your credit score.

The bottom line

Personal loans can help you build credit if you use them to consolidate debt or establish a timely payment history. If you choose to use a personal loan for credit building, remember to be aware of the risks involved and compare quotes from multiple lenders to ensure you get the cheapest possible loan for your situation.

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