It is essential to know about personal loans because they can help you increase your credit score through various means, such as reporting a positive payment history and ensuring you handle everything on time. Of course, taking a personal loan comes with certain risks, including additional debt, hard credit inquiries, and lender fees.

However, you can boost your credit score by getting a secured credit card, becoming a co-signer on a credit account, and reporting alternate payments to increase your overall history.

Since personal loans also function as a debt, you should know they can be perfect tools for boosting credit scores. This is because they will directly affect your payment history and overall rating, reducing the utilization ratio. Credit history, utilization ratio, and on-time payments account for seventy-five percent of your credit score.

However, while they are perfect tools for building credit, that does not mean you should use them. Before deciding, you should determine whether you can handle monthly installments and assess the risks.

We can differentiate three ways a personal loan can boost your credit, including:

• Repayment History – When you take out a loan, lenders will report your payment activities to three major bureaus: Equifax, TransUnion, and Experian. You should know that on-time payments will impact your credit, approximately thirty-five percent of your FICO score.
• Addition to a Credit Mix – The more different and diversified credit accounts you have, especially if they are in good standing, directly show that you can manage debts responsibly. At the same time, you can add a personal loan to your report because you will combine various credits, which will take ten percent of your score.
• Credit Utilization Ratio – For instance, using a personal loan to consolidate long-standing and high-interest debts, such as lines of credit or credit cards, will reduce the overall utilization ratio. This factor is responsible for thirty percent of your FICO score. It will help you measure how much credit you have used compared to the available limit.

Which Personal Loans are Perfect for Building Credit?

The main idea is to maintain payment consistency, which will affect the regular payments and become part of your report. Therefore, we can differentiate different subtypes of personal loans, such as credit-builder and debt consolidation, which are perfect options that will help you increase your credit score.

1.   Debt-Consolidation

As the name suggests, these loans will help you consolidate debt. For instance, you may have three credit cards with high interest rates and outstanding balances.

When you decide to consolidate debt, you will borrow money to pay off the outstanding balances from all the cards you have been using and streamline them into a single payment with a lower interest rate.

That way, you can boost your credit score in a few transparent ways. For instance, when you repay the outstanding balances from a few cards you used, the credit utilization ratio will immediately drop, making your score healthier.

Besides, you will boost credit diversification since the scoring models will take advantage of various debt options, including revolving debt or credit cards and installment loans or personal loans.

Besides, it is a sensible solution when you decide to consolidate debt since personal loans feature lower interest rates than credit cards, meaning you can rest assured, pay less, and increase your credit score simultaneously. On the other hand, you would pay more interest throughout the loan’s life.

You can find a wide array of financial institutions available on the market, such as credit unions, banks, and online lenders, that will offer you debt consolidation loans. To qualify for the best terms, you will need a decent credit score, which should not be lower than 740. Besides, you will need a stable income.

Some lenders will allow you to use co-signers or co-borrowers, which could help you qualify for a better loan, especially if they have a higher score than you. It is vital to remember that debt consolidation loans are perfect for people who qualify for better interest rates and wish to take care of high-interest credit card balances by streamlining a few payments into a single one.

2.   Credit Builder Loan

When you take advantage of a credit builder loan, you must make fixed monthly installments for a specific period. Compared with regular personal loans, you will not have access to funds until you repay everything with interest. You can use the funds for anything you prefer when you get the funds.

Some borrowers choose this option to boost their emergency funds. Others use them to pay small debts or achieve short-term goals. Credit builder loans may be counterintuitive since you will gain access to the money after paying it off. However, you will establish a history of proper payments, boosting your score altogether.

At the same time, credit-builder loans are not for everyone, especially if you need emergency funds. You will also get some fees that will help you open the loan. However, everything depends on the credit, interest rates, and ability to handle the overall value. We recommend you click here to learn more about personal loans.

Similarly to other options, credit builder loans are available through online lenders, credit unions, and banks. If you wish to apply, you do not need to undergo a credit check but offer specific information. We are discussing your social security number, address, full name, bank account info, mortgage payment, or rent.

Bad Credit Personal Loans

For instance, you should avoid taking a personal loan or applying if your FICO score is below seven hundred points. Instead, using other means to boost your credit score would be best. The main reason is that bad credit loans come with higher fees and interest rates than other loans on the market.

Therefore, repayment will be much more challenging, and the chances are high that you will fall behind on payments. If you do so, you will default on your loan, further damaging your credit rating.

However, suppose you have a good credit score. In that case, it is still essential to consider the risks that will help you ensure the best course of action for your specific situation.

Hard Inquiry

Each time you decide to apply for a personal loan, the lender will conduct a hard inquiry on your report. These inquiries will cause the rating to drop by a few points, butrebuilding them after making a few on-time payments is simple.

One inquiry at a time is expected and manageable by lenders. Still, you should avoid making multiple inquiries quickly because that will significantly decrease your score. At the same time, lenders consider regular applications a risk factor, meaning you will get higher interest rates.

The main goal is to stay on top of your payments, which is essential for consolidating debt and ensuring the best credit score possible.

Gain Debt

According to a few reports, people worldwide do not feel financially secure, and some state that the reason for that is high-interest credit cards affect their everyday lives. Therefore, you can apply for a personal loan, which will help you build credit, but that will directly translate into higher debt in your portfolio.

As a result, you should thoroughly evaluate your situation before signing anything. We recommend you understand that taking out a loan can cause hardship, even if you use it to repay the high-interest debt and reduce interest rates.

Additional Expenses

Everything depends on a lending institution, but the loan will likely feature at least one fee you must handle. Although we may talk about the minor costs compared with the amount you will get when a lender asks for multiple fees, that could directly affect the value of your loan and cause it to be reduced.

We recommend you read the terms and conditions to understand the fees associated with the process before accepting anything. If a lender chargesmultiple fees, choosing someone else is the best action. Some companies will charge lower fees, but the chances are low that you will find a lender without a single.

Other Ways to Boost a Credit

If a personal loan is not the best course for building a credit score, you can choose alternative methods. Of course, you must use them responsibly, which will help you increase your score after a while.

• Secured Credit Card – These cards require you to deposit in a separate account, which will later become your credit limit. Therefore, secured cards can boost your chances of making on-time payments. Of course, we are talking about taking a small portion and repaying it before the next billing cycle. If you neglect the payments, the lender or provider will seize your deposit.
• Joint Accounts – Another way is to find someone with a high score who agrees to co-sign on a loan or allow you to become an authorized user of their credit card. That way, you can avoid using a card, while the owner should make on-time payments, and they will affect your credit history and payments. Of course, co-signing has more severe implications than becoming an authorized user because you will be legally responsible.
• Alternate Payments – Sometimes, you can state additional payments you make to boost your history and score. We are talking about monthly subscriptions, streaming services, and utilities, which are not common but can help lenders determine your seriousness.

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