Credit scores can play an important role in your financial world whether you’re prepared for it or not. Things like car loans, mortgage rates, credit card limits, and more are all affected by your credit score. Interest rates can vary greatly based on your credit rating and have a low score can really hurt you financially in the short and long term. The higher your credit score and better your credit report the more likely you’ll be approved for things like a mortgage but also at a better rate, saving you money.
With this in mind, it’s important to build your credit rating up as much as you possibly can. There are lots of different ways to build your credit like secure credit cards, paying bills on time, and more; but here we’ll look at how you can build your credit score through a personal loan.
Using a Personal Loan To Build Credit
Through a personal loan, you can build credit in a few different ways, but some of those ways carry more risk than others. Let’s take a look at the traditionally safer methods that you can utilize today. But no matter what it’s important to conduct smart credit practices and don’t go spending a loan you receive on a shopping spree or spontaneous vacation. It’s also smart to put your monthly payments on auto-pay so you never have to think about paying things on time, it will be done on time automatically for you. On-time payments are a huge factor in your credit score so be sure you address this from the start. Also, it’s a smart idea to never “bite off more than you can chew” meaning don’t spend money you don’t have as this can really hinder your credit progress.
Credit Building Loans
This variety of loans is a “credit-builder loan” where you pay a fixed monthly amount towards paying back the loan you’ve received. You don’t get the money upfront, you actually get the funding after you’ve paid everything off (plus the interest and any fees). It may seem a little bizarre, “wait I don’t get the money until after I pay it off, how does that make sense?”. But that is exactly the way it is designed to work. You build your credit score through paying the monthly payments on time and afterward you receive the funds via a savings account. Then the cash is entirely yours and you’ve actually built your credit up through the on-time monthly payments.
Consolidating Debt
Personal loans are also often used to consolidate debt. For example, let’s say you have 4 credit cards with current outstanding balances. You’re paying each card every month, which means four different payments and four different interest rates. The way a personal loan works is that you borrow what is needed to completely pay off all 4 cards at once. You receive the loan and pay off all your credit cards with that money. Then you simply pay a single payment every month towards the personal loan. This can be a huge money saver as you can also get a better interest rate on a personal loan in comparison to multiple credit cards. You improve your credit score by making monthly payments on time and completely reset your credit card debt to zero. Two powerful items when it comes to your credit rating.
What Are The Risks?
Though personal loans can be a great way to build your credit, it is not without risks. It’s a decision you should put some thought into and do some research about. Here are the most notable risks in obtaining a personal loan to build credit.
More Debt
Every loan (through a credit card, mortgage, or personal loan) increases the amount of debt that you have. This may seem like a no brainer but it should be kept in mind as if you already have a good amount of debt taking on more could not only hurt your credit score but also put you in financial trouble. If you have a personal loan to build your credit be sure you’re not spending money in other areas that you don’t need to. Getting in the long term debt cycle is never good for you financially or your credit score. You should go into a personal loan to build your credit with a clear plan and time frame for paying that off without adding more debt. The idea is to pay off your debt not increase it.
Hard Inquiries on Your Credit History
Every time you apply for any type of loan the lender will conduct what is known as a “hard inquiry”. This is when the lender pulls your entire credit report to determine if you are eligible for loan approval or not. This creates a short term drop in your credit score that can last up to a few months. Having this happen once or twice won’t destroy your credit score but if you apply for a lot of loans from different lenders it will mean lots of hard inquiries onto your credit history. This is not good and will reduce your credit score. So it’s good to know your current credit score and what are the requirements from a lender prior to applying so you don’t get many hard inquiries without approval.
Fees Attached to a Personal Loan
Paying off the principal and the interest isn’t all that you may pay for when taking a personal loan. There are also associated fees for just about every loan available on the open market. Although this may seem like a small issue compared to the loan amount or its interest, you do want to at least be aware of what the fees are and how they are determined. Be sure to know the fees so you can keep it in mind and add that into your calculations for the total cost of the loan. Don’t be taken by surprise by even small fees.
Other Ways To Build Credit
Cosigners
Having a cosigner on your loan can also help you build credit. The way it works is that the responsibility to pay back the loan is shared by you and your cosigner. If you trust the person to make monthly payments on time it can be a good way to ensure approval of the loan and build credit. But, the caveat is that if the cosigner misses a payment or completely defaults on the loan, you’re not only legally responsible for the remainder of the loan but it will also hurt your credit score. So only do this if you and the cosigner are sure they can pay the terms of the loan on time.
Secured Credit Card
This is a variety of credit cards where you actually pay in money as collateral against the credit you’ll have on the secured card. A secured credit card is different from a traditional credit card in the way in which it determines your credit amount or limit. Instead of using your credit history as a traditional credit card a secure card provides a limit based on the amount you pay in as collateral. After you pay off the credit amount you get back your initial collateral investment. This builds credit and allows lenders to provide the card because they know you can pay it back as you’ve already put the money in. You’re essentially providing your own credit card to yourself with a secure card as you are essentially your own lender. Be sure to make payments on time though because even if a secure card basically uses your own money, you’re still receiving it through a lender. So making on-time payments is a must in order to build your credit score. Missed or late payments will hurt your score.
Verdict: Personal Loans to Build Credit Score
There are lots of different ways to build your credit score and as we’ve seen above there are some real benefits to building credit through a personal loan. Either through debt consolidation, a credit-building loan, a secure credit card, or getting a cosigner. Be sure to weigh all your options and the risks before moving forwards but a personal loan can absolutely be a great way to build your credit.
