How to Use a Personal Loan to Build Credit

A personal loan may be a great option for debt consolidation, home and auto repair, and much more. But did you know that a personal loan may also help build your credit if you manage it properly?

From improving your payment history to adding to your credit mix, we’ve gathered the top ways to use a personal loan to build your credit score so you can decide if that’s the right type of loan for you.

Why having strong credit is important

Before discussing the impact of a personal loan on your credit, take time to understand what credit is and how it works.

Credit is an essential building block of personal finance. It not only determines if you can get a loan, but what kind of interest rate you’ll receive. Insurance companies, phone and utility companies, employers and landlords may also check your credit when deciding to approve your application or open an account.

It’s always helpful to know the importance of credit, as well as how it’s measured and some simple tips to boost your score as you work toward improving your credit profile.

Do personal loans build credit?

Here are some ways a personal loan can help increase your credit score:

Improve or maintain payment history

Making up a whopping 35% of your credit score,¹ payment history can significantly impact your score. Getting a personal loan and making your monthly payments can help give your credit score a boost. Timely payments can also help you avoid late fees and other charges from your lender.

Reduce your credit utilization ratio

Understanding credit utilization starts with understanding what revolving credit is. Revolving credit lets you borrow money on a repeated basis up to your credit limit without a specific end date to pay off the full amount. Once all or part of the balance is paid, the same amount becomes available to use again.

Your credit utilization ratio is the percentage of total credit used compared to the total credit you have available. If you decide to pay off credit card debt with a personal loan, you can reduce the amount of revolving debt you owe, which could lower your credit utilization ratio and possibly raise your score. And since your credit utilization ratio is based solely on revolving credit, a personal loan (a type of installment loan) does not add to your utilization ratio.²

Add a different type of credit to your credit report

Variety can be good for your credit score. Since your credit mix accounts for approximately 10% of your score, opening a personal loan (or similar installment loan) can also strengthen your credit score so long as the loan is kept in good standing.

Build your credit history

When it comes to your credit score, the longer you have an account in good standing, the better. If you need to start building your credit history, getting a personal loan, then paying it on time for the length of the loan, is a great way to get started.³

Pros and cons of using a personal loan to build credit

Pros

• Pledging collateral is optional

  While collateral, a valuable asset like a house or car, may not be required for personal loans, using collateral can result in a higher loan amount and/or better terms. Remember that if you decide to use collateral you risk losing it if you fail to repay the loan according to the agreed terms.

• Quick access to funds

  [Personal Loans](https://www.onemainfinancial.com/personal-loans) can provide quick access to funds, which may be helpful if you want to immediately start paying off your debts and improving your credit score.

• Debt consolidation

  Personal loans can be used to consolidate high-interest debts such as credit card debt. If you qualify for a lower loan interest rate, you can potentially lower your overall interest payments and simplify your debt management. However, keep in mind that a new loan typically means a longer repayment period. While the monthly payment may be less, the total amount of interest you pay over time could be more.

• Fixed monthly payments

  A personal loan usually comes with predictable fixed monthly payments over a specified term, making it easier to budget.

Cons

• Interest rates and fees

  Depending on your creditworthiness, a personal loan may come with a high interest rate, particularly if you have a limited credit history or a low credit score. Some lenders may also charge additional fees or prepayment penalties, adding to the overall cost of the loan.

• Limited borrowing

  Unlike credit cards, which have revolving credit lines, personal loans provide the borrower with a lump sum that must be repaid over time. Once the lump sum is disbursed, there are no additional funds available without taking out a new loan.

• Risk of default

  Taking on additional debt through a personal loan increases your financial obligations. If you fail to make timely payments or default on the loan, it can have a severe negative impact on your credit score and overall financial health.

Alternative options to build credit

If you're aiming to improve your credit score without taking out a personal loan, here are some alternatives you can consider:

Use the accounts you already have

If you already have a credit card or personal loan, you might not need to apply for a new one. Using your existing account regularly and responsibly and making timely payments may positively impact your credit score. For example, you can use your credit card for only one specific use (for instance, to pay for gas each month) so you manage the balance wisely while keeping the card active.

Credit cards

If you don’t already have a credit card, applying for and responsibly using one may be a useful tool for your credit history. Depending on your situation, you might have various options available. If you're a student in college, you may qualify for a student credit card. Some retailers offer store credit cards that might not require credit history.

If you are building or repairing your credit, you may also want to consider a secured credit card. Secured credit cards require a security deposit from the borrower. The security deposit is refundable and reduces risk for lenders. The credit line of the secured credit card is typically the same amount of the deposit. While these cards may have higher interest rates and fees, paying your bill on time and in full each month could help you avoid interest charges.

If you don't qualify for a credit card yourself, becoming an authorized user on a friend or family member's account may help boost your credit score. As an authorized user, the account holder’s account activity will reflect on your credit report. Keep in mind that if the credit card account becomes past due, it will also negatively impact your credit.

A credit-builder loan

A credit-builder loan offers the dual benefits of building credit and saving money at the same time. With this type of loan, the lender holds a portion of the loan amount in a savings account. You make monthly payments toward that account, and once the loan term ends, you receive the balance. This option allows you to establish a positive payment history while also accumulating savings.

Use a personal loan wisely

When managed correctly, you could use a personal loan to build your credit. But it’s only one way to help strengthen your score. Building your credit score takes time and effort. Make the right moves, stay on track, and your credit could reflect your efforts!

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1. Jayakumar, Amrita. “How Does Payment History Affect Your Credit Score?” NerdWallet.com. https://www.nerdwallet.com/article/finance/payment-history-affect-credit-score (accessed April 9, 2021).
   
2. “What is a credit utilization rate?” https://www.experian.com/blogs/ask-experian/credit-education/score-basics/credit-utilization-rate/
   
3. Luthi, Ben. “Should I get a personal loan to build credit?” CreditKarma.com. https://www.creditkarma.com/personal-loans/i/loan-to-build-credit (accessed April 6, 2021).

   This article has been updated from previous postings in 2019, 2021,2023 and 2024. Matt Diehl, Lisa Weinberger and Kim Gallagher were contributors.