Taking Out a Personal Loan May Help You Improve Your Credit Score—But Should You?

If you’re trying to boost your credit score, you may be willing to try anything, including taking out a personal loan. It can work, but how much success you’ll have depends on your unique financial situation. The best prsonal loans can help establish a positive credit history, and they also help if you use the funds to pay off debt and keep it off. We’ll help you decide if this is the best course of action for you or if you should focus on other credit-building strategies.

Key Takeaways

If you use a personal loan to pay down existing debt and you repay the loan, you might see your credit score improve.
Taking out a personal loan and using the funds for purchases like a vacation, medical expenses, or big-ticket items can harm your score even more.
To boost your credit score, you could focus on paying down existing debt, using a secured card, and becoming an authorized user on another person’s credit card.

Should You Use a Personal Loan to Build Credit?

A personal loan typically is unsecured and can be used for many reasons, such as a home renovation or a large purchase. Unlike a mortgage, you don’t always have to put down collateral to qualify.

Personal loans can be a useful credit-building tool, especially if you don't have much credit history. Taking out a loan and paying it back on time and in full can do wonders for your score. Each payment you make is recorded with credit monitoring bureaus that look at various factors to determine your score.

Payment history accounts for 35% of your credit score and how much you owe makes up another 30%. So, whether you're taking out the loan to establish a credit history or using the funds to pay off existing debt, responsible repayment of a personal loan can boost your score. Taking out a personal loan and paying it off shows lenders you can pay back money properly.

Pros and Cons of Personal Loans

Pros

Adds to your credit mix
Consolidating debt can make it easier to manage
Interest rates are fixed
Can improve your score if you pay off outstanding debt
Can help establish credit history

Cons

Missing a payment can hurt your score
Hidden fees and charges
Higher interest rates for poor credit
Easy to take out too big of a loan

Considering a Personal Loan? First, Ask Yourself These Questions

Personal loans may be right for some people, but for others, not so much. After all, you’re taking on substantial debt. If you miss payments or struggle to pay off the loan, your credit score will suffer. Before you apply for a personal loan, run through these questions to get an idea if personal loans are the right move for you:

What is the interest rate?
How much interest will you pay in total?
Can you afford the monthly payments?
Are there any fees and penalties?

Why you want to take out the loan is one of the biggest issues to consider. You won't be able to take out a personal loan for things like education expenses, a down payment on a house, or investing, for instance.

Alternatives to Boost Your Credit Score

Taking out a personal loan to pay off your debt is tempting, but you have other credit-building options that don’t involve taking on more debt. Here are just a few:

Ask someone to add you as an authorized user on their card: If your credit is poor or nonexistent, you might not qualify for a personal loan. If that’s the case, ask a trusted relative or friend to add you to their credit card as an authorized user. This helps you establish and build credit.
Use a secured credit card: Instead of using an unsecured credit card, start using a secured one to avoid interest and overspending. To use a secured card, deposit money into the account. This becomes your card’s credit limit.
Use less than 30% of your credit card limit: Credit monitoring bureaus look at how much debt you have in comparison to available credit. This is known as your credit utilization ratio. FICO recommends keeping your ratio under 30%.
Always make your payments on time: Whether you’re paying your credit card bill, phone bill, or bill for streaming services, you should make a point of paying at least the minimum on time. Missed payments can cause your credit score to plummet.