Credit scores are a daily factor in our lives, whether we know it or not. The better your credit score, the more credit is available to you and the less interest you will have to pay. If you have bad credit, you will have difficulty accessing affordable credit.
One way to improve your credit health is to take out a personal loan. Used responsibly, a personal loan could help you pay off your debt or create a good payment history, which could boost your credit score. think.
Ways to Build Your Credit Score With a Personal Loan
You can use a personal loan to build your creditworthiness in a variety of ways. The most popular options are generally debt consolidation loans and credit creation loans.
Debt consolidation loan
As the name implies, these loans are personal loans used to consolidate debt.
Imagine you have three credit cards, each with an outstanding balance. You make three payments each month with three interest rates. A debt consolidation loan allows you to borrow the money needed to repay all three cards and repay this loan with one payment per month, often saving money in the process due to lower interest rates.
This can help your credit in a number of ways. First, repaying your credit card balances will lower your credit score – a key factor in your credit score. You can also improve your credit score, as credit rating models like to see a variety of recyclable debt, such as credit cards and installment loans, such as personal loans.
Who is best for: Debt consolidation loans are ideal for people who want to consolidate the rest of their high interest rate credit cards into a more competitive interest rate loan to save money and streamline the repayment process.
A home equity loan is a loan product that requires you to make fixed monthly payments over a fixed period of time. Unlike traditional personal loans, you will not have access to the funds until the loan is fully repaid with interest.
Once the money is released to you, it is up to you to use it as you see fit. Some borrowers choose to increase their emergency fund. Others use the funds to pay off small debts or achieve other short-term financial goals.
These credit cards can be contradictory, as you will not have access to the borrowed money until you have repaid it. However, you will create a timely payment history, which the lender then reports to the credit bureaus. At that point, the money is yours without ties, fully paid. It’s like putting money in a savings account, but with the advantage of a credit boost.
Keep in mind that a home equity loan is not for everyone. You may have to pay commissions to open the loan and you will have to include any interest on the amount you pay each month.
Who is best for: Credit loans are best for people with bad credit or no credit history who want to save money when creating credit.
Risks of using personal loans to create credit
While personal loans can be helpful in improving your creditworthiness, there are also some risks. Before taking out a loan to create credit, think carefully about these risk factors and make sure that getting a loan is the right choice for you.
Tough research on your credit report
Each time you apply for a personal loan, you will receive what is known as “hard research” in your credit report. Your credit score may drop, but the impact will generally not last more than a few months. While one of these is manageable, it can be detrimental if you shop for loans and end up with multiple hard drives on your credit report.
Every loan you take out is a debt you take on. Remember, you do not have to take out a loan if the debt is going to cause financial hardship. Even when using your personal loan to pay off debt and lower interest rates, it is vital that you limit any spending behavior that adds more debt while repaying your personal loan.
There is more to paying on a personal loan than the amount you borrowed interest. Commissions are associated with almost every loan available. Although it is a small cost compared to the loan itself, you do not want to be blinded by these charges. Be sure to read the fine print to find out what commissions are associated with any loan before signing the dashed line.
Alternative ways of creating credit
A personal loan is not the only way to improve your credit score. Consider the benefits and risks of alternatives, such as secure credit cards and shared accounts.
Secured credit card
A secured credit card is a special type of credit card that uses money that you have pledged into a specific account to serve as a guarantee against the credit limit you have on the insured card. The credit limit of a secure card is mainly based on the size of the security deposit you make when you apply for the card. Because you could lose your collateral if you lose payments, lenders are more likely to extend this type of credit card to people with or without credit. However, regular payments could boost your rating.
Co-signing a loan or becoming an authorized user on a credit card 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 benefit from the credit benefits.
Keep in mind that if the person you are signing up with loses any payments or defaults on the loan, then not only will it damage your creditworthiness, but you will be legally liable to make up for lost payments.
Alternative payments were reported
Some service providers may be willing to report account activity to credit bureaus upon request. Consider contacting mobile, ancillary and cable providers and asking if they would report payments to the three major credit reporting companies – Experian, TransUnion and Equifax – on your behalf. You can also ask your landlord to report rent payments.
The bottom line
Personal loans can help you build credit if you use them to consolidate debt or create a timely payment history. If you choose to use a personal loan to build credit, remember to be aware of the risks and compare offers from many lenders to make sure you get the cheapest possible loan for your case.