At a Glance

Personal loans can be used for just about anything, including debt consolidation, home renovations, paying for a wedding or vacation, covering moving costs, and more.

You can also use a personal loan to build and improve your credit history, as long as you have a solid credit history and can qualify for loan terms and interest rates that won’t cost too much. There are a number of factors having and paying back a personal loan can influence, but it’s important to use the funds wisely or risk negatively affecting your score.

In this article, learn more about:

How can you use a personal loan to build credit?

Your credit score is important – it can affect rates you get on a loan or other funding, whether you’re approved for an apartment or mortgage, and even your insurance rates. If your credit score could use some work, one of the ways to improve it could be by taking out a personal loan.

A personal loan is debt, so this may sound counterintuitive, but the loan can help with a few of the most important factors that influence your credit score:

  • Payment history: Because it makes up 35% of your score, it’s important to make your payments on time. This shows you’re a responsible borrower and can help build your credit.
  • Credit utilization: Credit utilization, which makes up 30% of your score, is the amount of revolving credit you’re using divided by the total amount of credit you have available. A “good” utilization ratio is typically less than 30%. If you’re taking out a personal loan to consolidate debt or pay off credit card balances, this lowers your credit utilization.
  • Length of credit history: Length of history makes up 15% of your score, and having a longer credit history can help show your responsibility with credit over time. If you don’t have any other credit, a personal loan can help start the process of building your credit profile.
  • Credit mix and types: Making up 10% of your score, how much debt you have and what kind of debt it is helps show how well you manage credit. Having varying types of credit, like credit cards, personal loans, auto loans, and/or student loans, can help boost your score because you’re showing you’re able to handle a variety of credit products.

Overall, if you’re using a personal loan to build credit, it’s critical to make the monthly payments on time each month. This, along with lowering your debt-to-income ratio and credit utilization, helps show you’re responsible with borrowed funds. Having a mix of different types of credit, and having a longer credit history, can also help prove you’re a responsible borrower and that you manage credit well, all of which will improve your score.

On the other hand, if you make late payments or miss payments completely, this can significantly decrease your credit score.

Related: Good reasons to get a personal loan

Dos and Don’ts of using a personal loan to build credit

Do Don’t
  • Only take out a personal loan if you need it, such as for consolidating debt, funding home renovations, paying medical bills, or paying for a wedding, vacation, or other large purchase.
  • Only borrow the amount you need, which will keep your payments more manageable, and you’ll be charged less in interest over time.
  • Pay off the loan in full and on time each month.
  • Compare lenders to find the best term, interest rate, and features.
  • Create a budget to make sure you can afford the monthly payments.
  • Prequalify, which doesn’t affect your credit score and can show estimated monthly payments, interest rates, loan amounts and terms you’d qualify for.
  • Carefully read the terms and conditions of the loan agreement before signing it to make sure there aren’t penalty clauses and you understand how it will be reported to the credit bureaus.
  • Take out a personal loan to finance an extravagant or unnecessary purchase.
  • Take out a large loan amount just to have the extra cash, as you’ll end up paying more in interest over the life of the loan.
  • Stop using credit cards, even if you are using the loan funds to pay off credit card debt. Activity from your cards and your loan will help build your credit score.
  • Apply for multiple loans. While prequalifying does not affect your credit score, an application will trigger a hard credit inquiry, which will slightly decrease your score.
  • Apply for other types of loans or take on additional debt, because even though this improves your credit mix, it will increase your credit utilization ratio.

Personal loan alternatives for building credit

Depending on your current credit score and history, a personal loan may not be the best option for building credit. High interest rates, unfavorable terms, or other downsides to personal loans may outweigh the positives if you’re just using it to build credit. Plus, some personal loan lenders don’t report to the major credit bureaus, so your activity wouldn’t even help.

There are alternatives to a personal loan that can still help you build credit that may be a better choice depending on your financial situation, including:

  • Credit-builder loans: These loans are designed specifically for borrowers who are looking to build credit. Instead of receiving the loan funds, the lender would deposit the sum into a locked savings account. Over the next six to 24 months, you’ll make monthly payments and the lender will report this to the credit bureaus.

After the loan term is over, you receive the full loan amount plus any interest accumulated from the savings account.

Interest rates for these loans can vary, but one through a federal credit union cannot be more than 18%.

  • Credit cards: If you have no credit, or limited credit history, you may qualify for an unsecured credit card or student credit card (if you’re in school). While these charges have high interest rates, you avoid this if you pay off your bill in full and on time each month.

If you can’t or don’t want to get your own card, you can get added as an authorized user on a family member or friend’s card account, so the activity with the account can also show up on your credit report and improve your score.

  • Existing credit: If you have an auto loan, student loan, mortgage, credit card, or other type of loan already open, you can use these existing accounts to improve your credit instead of taking on a new loan.
  • Peer-to-peer loan: If you have poor credit, consider applying for a peer-to-peer loan (P2P). Instead of getting a loan at a bank or credit union, you borrow from individuals who are strangers. This takes place on an online platform that connects borrowers with investors, who supply the funds and you’d repay as you pay off your loan.
  • Home equity loan (HEL) or home equity line of credit (HELOC): This loan or line of credit lets you borrow against the value in your home. If you have equity in your home already, you may qualify for a low rate. However, be sure you’re able to repay the debt; otherwise, you could lose your house.

Related: Home Equity Loans vs. Home Equity Lines of Credit 

Personal loans for bad credit

It’s possible to be approved for a personal loan even if you have poor credit (300-579), but it can be more difficult and more costly. The lower your credit score, the higher the loan’s interest rate will be, so the more money you’ll pay over time. You’ll likely find better rates with online lenders than banks or credit unions.

You can also explore secured loans instead of unsecured loans. A secured loan has collateral backing the loan, like a vehicle, so you’re considered less of a risk and lenders are more likely to approve your application. Secured loans also may have lower interest rates for those with bad credit than unsecured loans.

Related: Secured vs. Unsecured Personal Loans

Adding a cosigner to your loan can also improve your chances of getting approved, as this adds a responsible borrower to your loan and helps guarantee payment.

Some lenders have minimum credit score requirements, often around 580, but if you qualify, a small personal loan can help improve your credit as long as you make the payments on time.

FICO®, which is the most used credit scoring system, breaks credit scores down into five categories, ranging from “poor” to “excellent.” The full breakdown is below:

  • 300-579: Poor
  • 580-669: Fair
  • 670-739: Good
  • 740-799: Very Good
  • 800-850: Excellent

Lenders consider anything in the “poor” or “fair” range to be “bad credit.” That doesn’t mean you can’t get approved for a personal loan if your score falls in those ranges. Fair credit scores are often approved, but the fees and interest rate will be higher. Applicants with “poor” credit may not get approved. Speak with a credit counselor if you’re in that situation.

FAQ

How long does it take for a personal loan to hit your credit?

A hard inquiry from applying for a personal loan will hit your credit report during the same cycle and stay on your report for two years. Each month that you make the loan payment and pay down the total, your credit score may increase by a few points.

How long does it take for a personal loan to hit your credit?

Lenders report payments on their own schedule, typically every 30 to 90 days. Most lenders report monthly payments monthly, so your loan will show up on your credit report when you make your first monthly installment payment.

Can I get a personal loan with a credit score of 600?

There are bad credit lenders who will approve you if you have a credit score of 600, but you’ll pay more in fees and a higher interest rate than good credit borrowers.