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A personal loan is one way to build credit, but it’s not your only option. (Shutterstock)

Taking out a personal loan can help you build credit—if you do a good job of paying off the loan. On-time monthly payments can boost your credit score.

However, if you miss payments or are late, those negative marks can linger on your credit report for years, potentially making it difficult to qualify for other types of financing, such as a car or home loan.

How to build credit with a personal loan

If you’re neck-deep in credit card debt, you might want to consider a debt consolidation personal loan. This type of loan consolidates your current debt into one loan with one monthly installment, preferably at a lower interest rate and on better terms.

Personal loan interest rates are generally lower than most credit cards, and you have a predictable payment each month. If you apply, your credit may be temporarily affected, but if you make all your payments on time, A debt consolidation loan can help build your credit score.

Factors affecting your credit score

When reviewing your application for a personal loan, lenders will check your creditworthiness. But that’s not the only thing they consider. You can also look at your employment history, debt to income ratio, and whether you have a co-signer or collateral.

The three major credit bureaus use these five factors to determine your credit score:

  • payment history – Your payment history is the most important factor in determining your creditworthiness. If you consistently make timely payments on your personal loan, your credit score is likely to improve over time. But if you make late payments or miss payments, it can affect your credit score and stay on your reports for up to seven years.
  • Amounts owed — When deciding whether to give you a loan, lenders look at how many of your accounts have balances and how much you owe on each. So, repaying or repaying a personal loan can have a beneficial impact on your credit score.
  • Credit History Length — The credit history takes into account all new accounts, the age of your oldest accounts, and the average age of all your accounts. When you repay a personal loan, it can stay on your credit report for up to 10 years. During this time, it can still help improve your overall score.
  • credit mix — A mix of different types of credit—credit cards and loans—can improve your credit score. If you have credit cards and take out a personal loan and manage it well, you can improve your credit score over time.
  • New Credit — Taking out a personal loan can lower the age of your accounts but also improve your credit score by increasing your available balance.

Potential Disadvantages of Using a Personal Loan to Build Credit

Along with all the benefits of Using a Personal Loan to Build Credit, you must also consider the potential risks:

  • Monthly payments – Depending on the rate and terms of the personal loan, you may find yourself overstretching your budget just to make your monthly payments. When that happens and you default on your loan, your credit score suffers. Before agreeing to a personal loan, make sure the monthly payment fits your budget.
  • High interest rates — For people with good credit Interest on personal loans can be much lower than many credit cards. However, if you have bad credit or a poor credit history, you may get higher interest rates, which means you pay more interest over the life of the loan.
  • Fees and Penalties — Some personal loans have an origination or processing fee that ranges from 1% to 8% of the loan amount, depending on your credit rating. Lenders may also charge prepayment penalties for prepaying your loan, so it’s best to check the terms of your personal loan beforehand.
  • Can Increase Your Debt Burden – A personal loan can help pay off or pay off high-interest debt. But if you start accumulating more credit card debt once you’ve paid it off, it will increase your debt burden and defeat the purpose of taking out a personal loan.

Personal loan alternatives for the construction loan

If you want to build credit but a personal loan isn’t right for you, consider these alternatives.

construction loan

A construction loan is designed for people with no or bad credit. A traditional personal loan allows you to borrow money up front and pay it back over time. But with a credit-building loan, the lender transfers the loan amount — typically $300 to $1,000 — into a blocked escrow account.

You pay in installments, usually over six to 24 months, into a special savings account. Your payments will show up on your credit reports, which can help build credit over time. And at the end of the term, you get back the amount in your savings account, minus interest and fees.

Personal Line of Credit

Personal lines of credit are unsecured revolving credit accounts. Similar to a credit card, you can withdraw money up to a limit when you need it. When you withdraw money, your available balance decreases. When you pay back the borrowed amount, your available balance will be restored.

A downside to personal lines of credit is the potentially higher interest rate on the amount borrowed than some credit cards or personal loans. Also, some accounts charge overdraft and annual fees, and there’s always a risk of overspending.

Home equity loan or line of credit

If you have equity in your home, a home equity loan or line of credit can be a good alternative to a personal loan. These loans are secured by your home, so you can often qualify for a lower APR than a personal loan. Plus, you can use the credit for almost anything. However, remember that if you are unable to repay the loan, you risk foreclosure since your home is being used as collateral.

0% Intro APR Credit Card or Secured Credit Card

Although many credit cards come with relatively high interest rates, they can be a good credit-building option if you can find a card that includes an introductory offer of 0% APR for a period of time. As long as you withdraw your credit card balance before the end of the promotion period, you will not pay any interest on the amount. Just make sure you can pay the balance in full before the promotion ends, otherwise interest will accrue at the card’s regular rate.

If you have bad credit, it can be difficult to qualify for a 0% APR card. Instead of this, You may qualify for a secured credit card this helps you build credit over time. As your credit improves, you may be able to upgrade to an unsecured card.

Why good credit is important

If you’ve ever applied for a car loan, rented an apartment, or asked to lower your credit card interest rate, you know why good credit is so important. In addition to lower interest rates and better conditions, a good credit rating is crucial for your financial future.

If you need credit to start a new business, don’t want to pay a large down payment if you’re using utilities, or want to pay lower insurance rates for an auto policy, good credit can open up opportunities. Remember that building good credit doesn’t happen overnight. It takes time and commitment.

Tags : credit cardscredit scoreinterest ratespersonal loans
Richard Dement

The author Richard Dement