Can You Use a Personal Loan to Build Credit?

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Most Americans don’t have excellent credit. The average credit rating in the US is 687 which is considered good but not excellent.

Good credit helps you qualify for a mortgage, line of credits and bigger loans. But how can you build credit if you have none or have a poor score?

You can use a personal loan to build credit. Read on to find out how.

What Is a Personal Loan?

Unlike a mortgage or a car loan, a personal loan can be used for whatever you need. 

Personal loans range from $1000 up to $100,000. They might have a fixed or variable rate. 

If you have the option between a personal loan vs credit card, the personal loan is your best bet. The interest rate on a personal loan is often much lower than the interest rate of a credit card.  

Credit card interest rates vary. You may be paying 15% or more on your credit card debt. A personal loan may have an interest rate of 7%. That means that you would be paying less than half the interest than if you used a credit card. 

We will discuss how you can use a personal loan to build credit later on.

First, let’s go over the two types of personal loans.

Secured vs. Unsecured Personal Loans

A secured loan means that the borrower provided some sort of collateral to the lender in order to get the loan. A mortgage is a secured loan. If you default on your payments, the lender gets your house.

People often use their cars or another asset to get a secured loan from a lender.

A lender will give an unsecured loan to a person whose credit history proves that he or she is trustworthy and has a good track record. You don’t need to provide any collateral for an unsecured loan.

Not everyone can qualify for an unsecured loan. You need a good credit rating for a lender to decide that giving you money is a reasonable risk to take. 

A secured loan typically comes with a lower interest rate. That’s because there is less risk for the lender. If you default, they keep your collateral. 

Many times, secured loans are best for longer terms because you can save hundreds of dollars on interest. Unsecured loans are generally best for short-term use and for people who have excellent credit – check out this website to learn about getting loans with no credit check. 

How to Use a Personal Loan to Build Credit

You can use a personal loan to build credit. Here are some ways to go about it.

Consolidate Debt

First of all, you can use it to consolidate your debt.

If you have one or more credit cards with a balance, it is hurting your credit. Especially if any of your credit cards are maxed out. 

Transferring all your credit card debt to a personal loan is a good way to pay that debt down faster. The lower interest rate will allow you to pay more onto the principle each month.

Credit cards are revolving loans. They don’t have a fixed repayment term. You can keep borrowing and paying it down forever. 

But a personal loan is an installment loan. That means that you pay a fixed amount each month over a set amount of time. This guarantees that you will be paid off in full by a certain date. 

Don’t Rack up More Debt

Once you’ve got all your credit cards down to zero balances, be careful.

Don’t forget that you still owe the same amount of money as before. It’s all just in one place on your personal loan.

Don’t rack up more debt on your credit cards. You won’t improve your credit score if you are in more debt. 

Now is a good time to evaluate your spending. Are you wasting your money on meaningless shopping? Break that bad habit now and be closer to financial freedom.

Understand Credit Utilization

Having a personal loan and credit cards helps you build credit. And having all your debt in one place can help your credit score go up. 

Each month, your lenders send a report to the credit bureaus. The amount of money you owe versus your credit limit is your credit utilization.

You want to bring how much credit you use to below 30% of your credit limit.

So, when you move your credit card debt onto a personal loan, you are lowering your credit utilization. And you are also diversifying your debt types.

Automate Your Loan Payments

A big chunk of what determines your credit score is based on whether you pay your bills on time or not.

Your personal loan can help you build your credit when you ensure you pay on time, every time.

The best way to make sure that you aren’t late or miss a payment is to automate your payments. Set an automatic payment schedule from your bank account for a week before your monthly due date.

That way you pay on time without thinking about it. Over time, your credit score will begin to go up and up.

What to Look for in Personal Loans

Now that you understand how you can use a personal loan to build credit, you can start to shop around for the best personal loan.

Don’t just go for the first loan you find. Take time to research your options and compare them to see which is best.

Take a careful look at the borrowing limits, the length of the loan and the interest rates. 

Bottom Line

We hope you found this article about how to use a personal loan to build credit useful. Remember, there is no magic fix to poor credit.

It takes time and good financial practices. But it can be done. Over time, your credit rating will go up as you wisely manage your finances.

Next, get ready to become financially independent with these 7 tips.