How a Personal Loan Could Help Build Credit

Building good credit can take time, dedication and knowing the right moves to make. There are many ways to increase your score, and once you understand the basics of credit and why it matters, you'll have the knowledge you need to make it happen. Let’s get started!

Why good credit matters

Building good credit is important for almost everyone. Some people may think that credit scores only matter for those who choose to use credit, but that isn’t always true. Insurance companies, telephone and utility companies, employers and landlords could all pull your credit report and look at your score when deciding to approve your application or request of service.

Lenders and credit card issuers do the same, but even if they approve your application, a low score could mean a high interest rate. Having good credit can positively impact many areas of your life — not just loans and credit cards.

Building credit with a personal loan

"A personal loan can be a good tool for building credit. As long as you pay your personal loan on time each month, then it should build a positive credit reference that can help you build or rebuild credit," says Gerri Detweiler, director of Consumer Education at Credit.com.

Here are two ways a personal loan could help build credit:

1. Payment history
   A personal loan won't help you build credit if you're not making timely payments. If you're not paying your bills on time, your credit score will reflect it. As Michelle Singletary emphasizes in The Washington Post, "Paying your bills on time is the No. 1 way to fix your credit. Every debt. Every month. On time." FICO shares in its credit-score breakdown that 35% of a FICO score is determined by payment history.¹ Late payments or missing payments may hurt your credit score, but, on the flipside, building a record of on-time payments is the surest way to improve your credit over time.

2. Credit mix
   Did you know that there are generally two different types of credit? A personal loan or mortgage loan, for example, are considered installment credit. Most credit cards, on the other hand, are regarded as revolving credit.

Credit scoring models generally use five factors when determining your score: payment history, credit utilization, length of credit history, hard inquiries and credit mix. (There are other factors as well, but these are the top ones you should be aware of.) By adding a new type of credit to your credit mix, and handling it responsibly, you could give your score a boost. Be advised that when you apply for a loan, a hard inquiry can be noted in your credit report. This may cause a short-term drop in your score, but the effect will diminish over time.

Use a personal loan wisely

When managed responsibly, personal loans can boost your credit score by adding to your credit mix and improving your payment history. Stay on the right track and your credit will reflect your efforts!

*This article has been updated from its original posting on April 22, 2015.
Lisa Weinberger contributed to this article.