There are many reasons why people take out personal loans, such as to make urgent repairs, catch up on bills, or consolidate debt. However, another benefit of personal loans is that you can use them as a tool to improve and establish your credit.
So, how do personal loans build credit? And how can a personal loan build credit for you to improve your financial situation?
Our financial pros explore the answers to these questions in this article to help you use a personal loan to achieve financial stability and boost your future purchasing power.
How Personal Loans Affect Your Credit Score
Credit scores are numbers that represent your creditworthiness to lenders. Loan companies use your credit score to determine how likely you are to repay money you borrow.
The most important factor influencing credit score is payment history. This factor reflects whether you've made past payments on time, missed payments, or gone into default or collections.
Your FICO score relies upon credit history for 35% of the calculation. The total money you owe makes up 30% of your score. Meanwhile, the length of your credit history is 15%, your credit mix is 10%, and new credit is 10%.
Personal loans to build credit factor into your credit score calculation because they alter the way potential lenders see you as a borrower.
For example, a personal loan may improve your credit mix by diversifying it. If you make on-time payments for your personal loan, you’ll boost your payment history by showing lenders you are a reliable, responsible borrower. You can also reduce your credit utilization with a personal loan if you use it to pay off credit card debt.
4 Ways a Personal Loan Can Help Build Credit
Can personal loans build credit? Yes, personal loans like the ones we offer can help you boost your credit score in four important ways.
Helps Create a History of On-Time Payments
A positive payment history is crucial to securing loan funds and getting the best interest rates and terms. If you take out a personal loan, make sure to make every payment on time so that the loan improves your credit rather than harming it. Even one missed payment can have a negative impact on your credit score.
To keep you on track with timely monthly payments, you can set up personal calendar reminders on your mobile device or use a paper calendar where you’ll see payment reminders. Consider setting up auto-pay for your loan payments so that you don't have to worry about remembering them, since the money is automatically deducted from your account each month.
Improves Your Credit Mix
Another answer to the question, “How can a personal loan build credit?” is that it can improve your credit mix. Having both revolving and installment credit in your financial portfolio is beneficial.
A combination of installment credit (like a personal loan) and revolving credit (like credit card debt) offers variety and shows versatility in your money management skills. A diversified credit mix is an indicator that you are in good standing with multiple accounts and can manage numerous debts responsibly.
Can Temporarily Lower Your Credit Utilization
Many people use personal loans to pay off high-interest credit card debt. By doing so, you can lower your credit utilization, which is attractive to potential lenders you want to borrow money from.
Although this improvement is temporary, it might be just the boost you need to raise your credit score when you need it most.
Shows Responsible Borrowing Behavior
Personal loans to build credit also demonstrate that you are a responsible borrower who can stick to consistent, on-time payments.
One of our personal loans can help other institutions see you as a competent and reliable borrower who is low-risk. Because of this, you may have more opportunities and be able to afford and do things that could otherwise be a financial challenge.
When a Personal Loan Doesn’t Help Your Credit
However, there are circumstances in which a personal loan may not improve your credit and actually harm it.
Taking out personal loans to build credit will do you no good if you miss or make late payments. By failing to make every payment on time each month, you are hurting your credit.
If you already have many other loans and unmanageable debt loads, taking on a new personal loan could result in too much debt overall. Having high debt amounts can make it challenging to achieve your financial goals, such as buying a house or saving for retirement.
Applying for multiple loans at once results in multiple hard credit check inquiries. These hard inquiries can cause your credit score to drop a few points lower than it was before. However, this credit score hit is only temporary, and you can typically build your score back up after hard inquiries by making on-time payments in the future.
Red Flags to Avoid When Using Loans to Build Credit
- Late or missed payments
- Applying for multiple loans at the same time
- Borrowing more than you can afford
- Failing to work a new loan into your monthly budget
- Falling for a scam or choosing a non-reputable lender
How to Use a Personal Loan Strategically
Can personal loans build credit with the right strategy in place? Absolutely. Many of our customers have successfully improved their credit by taking out a loan from us and reaching a secure and comfortable financial position.
You can use personal loans to build credit by only borrowing what you genuinely need and no more. Don't overextend yourself financially because doing so can lead to missed and late payments.
To build credit, choose short-term loans with affordable repayment terms. This way, you’ll avoid long-term interest accruals and only need to keep track of your new loan for a limited time.
It is also crucial to work with a lender who reports to credit bureaus so that your credit can reflect the intended positive effects. Choose lenders in good standing with the Better Business Bureau to avoid predatory scams and offers that are too good to be true.
Service Loan South is an accredited lender with an A+ rating. We report to the major credit bureaus and are members of the Alabama Lenders Association, Georgia Installment Lenders Association, Tennessee Independent Lenders Association, and Texas Consumer Finance Association.
We have been in the loan business since 1974 and are dedicated to helping individuals and families make ends meet.
Alternatives to Personal Loans for Building Credit
Personal loans to build credit are helpful for many people, but there are additional options that you might consider before applying for one. Combining a personal loan with one of these alternatives may be possible for an even greater credit score boost.
One option is to get a secured credit card. This type of card requires a deposit in another account to serve as your credit limit. You can boost your credit with a secured credit card, but only if you repay the balance as you agreed upon.
You might also consider becoming an authorized user on a joint account to build your credit. You’ll be responsible for repaying the balance if the primary borrower defaults. But if you cosign with someone who’s financially responsible, a joint account could help your credit.
Certain services, such as Experian Boost, can help you raise your credit score for free by paying your rent, utilities, insurance, and cell phone bill through their system. For accounts you choose to link to your bank accounts, on-time payments are added to your Experian credit file.
Why Choose Service Loan South?
Service Loan South is a well-established, reputable lender with a local presence in many communities throughout the region. We offer excellent customer service, flexible loan terms, and affordable rates on our personal loans.
At Service Loan South, we value transparency and take a personalized approach to helping each of our customers find the best loan for their needs.
Please apply online or visit one of our local branches today to secure personal loans to build credit.
