A personal loan can be a useful tool for consolidating debt, funding home repairs, or covering unexpected expenses. Taking out a personal loan can also help you build credit over time, provided you use it responsibly. Like any credit product, a personal loan has the potential to either strengthen or weaken your credit profile, depending on how you manage it.
Understanding how personal loans interact with the components of your credit score can help you make smarter borrowing decisions. Let’s explore when a personal loan contributes positively to your credit — and when it doesn’t.
Table of Contents
Key Points
• Personal loans can favorably affect your credit file by improving payment history, lowering credit utilization, and adding credit diversity.
• Risks include late payments and increasing your debt-to-income ratio.
• Borrowing a manageable amount can help prevent financial strain and support responsible loan management.
• Automatic payments ensure timely repayment, crucial for maintaining a strong credit profile.
• Monitoring your credit reports can help you track your progress and verifying accuracy, essential for effective credit building.
When Does a Personal Loan Help You Build Credit?
Taking out a personal loan can help you build credit under the right circumstances. Here’s how it can positively impact various aspects of your credit profile.
Your Payment History
Payment history is typically the most significant factor in your credit scores, accounting for approximately 35% of your FICO® Score. When you make on-time monthly payments on your personal loan, you’re showing lenders that you’re reliable and responsible.
Each successful payment helps build a positive payment history. Over time, this consistency can have a favorable impact on your credit file, especially if you previously lacked installment loan accounts or had missed payments in your past. A single missed or late payment, on the other hand, can stay on your credit report for up to seven years, so timely payments are crucial.
Your Credit Utilization Ratio
Your credit utilization rate is the percentage of available credit that you’re using on your credit cards and other lines of credit, and is another important factor in your credit scores. While credit utilization typically applies to revolving credit like credit cards, a personal loan can still indirectly improve your utilization ratio. If you use a personal loan to pay off high-interest credit card debt, known as credit card consolidation, your credit card balances will go down, reducing your utilization.
For example, if you owe $4,000 on a card with a $5,000 limit, your utilization is 80%, which is high. But if you use a personal loan to pay off that balance, your credit utilization on that card drops to 0%, which can have a positive impact on your credit file. Keeping your utilization below 30% is generally recommended for maintaining good credit health.
Recommended: Personal Loan Calculator
Your Credit Mix
Your credit mix — meaning the different types of credit you have — accounts for about 10% of your FICO score. Lenders generally like to see that you can manage multiple kinds of credit, such as credit cards (revolving credit) and personal loans (installment credit).
If your credit history includes only revolving accounts, taking out a personal loan can diversify your credit mix, which could positively impact your profile. This diversity shows you’re capable of managing various types of debt responsibly.
Recommended: What Is a Credit-Builder Loan?
When Doesn’t a Personal Loan Help You Build Credit?
While a personal loan can build credit, it’s not a guaranteed outcome. Missteps in how you use or repay the loan can do more harm than good.
Late Payments
As mentioned, late payments can do serious harm to your credit file. If you’re more than 30 days late, lenders may report the delinquency to the credit bureaus. Even a single missed payment can cause your credit score to drop — exactly how much will depend on how late the payment is, your current credit score, and your overall credit history.
Consistently late or missed payments can turn a credit-building opportunity into a long-term financial setback.
Short-Term Loan
Personal loans with very short repayment periods — especially payday loans or high-fee cash advances — typically don’t do anything to positively impact your credit file. In many cases, these loans aren’t reported to the credit bureaus. Even if they are, they may not help you build credit because they don’t show a long-term payment history.
What’s more, frequent borrowing of short-term loans could be a red flag to lenders that you’re struggling to manage your finances.
High Debt-to-Income Ratio
While your debt-to-income (DTI) ratio isn’t part of your credit score, it plays an important role when applying for new credit. DTI ratio is of interest to lenders because it shows what portion of your income is already allocated to debt repayment. If your DTI ratio is relatively high and you add a personal loan, lenders may see you as overextended. This could make it harder to get approved for a mortgage, car loan, or credit card in the future.
Generally, you want to aim for a DTI ratio of 36% or less. This suggests you have a healthy amount of income to afford monthly payments for a new loan or line of credit.
To calculate your current DTI ratio, add up all your monthly debt payments, divide that total by your gross monthly income, and multiply the result by 100. This will give you your DTI ratio as a percentage.
Tips to Maximize the Credit-Building Potential of a Personal Loan
If you’re considering a personal loan as a way to build credit, these strategies can help you use the loan wisely.
Choose a Reasonable Loan Amount
It’s important to only borrow what you can reasonably afford to repay. Before signing the loan agreement, calculate your monthly payments and make sure they fit comfortably within your budget. Stretching your finances to take out a large loan can increase your risk of missing payments — and damage your credit.
Remember, the goal is to build credit, not add financial stress.
Set Up Automatic Payments
To avoid late payments, consider setting up automatic payments through your bank or lender. “Setting up autopay is one way to make sure payments are made regularly and on time,” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi.
Most lenders offer autopay options that draft your monthly payment directly from your checking account on the due date. Some even offer a small interest rate discount for using autopay. This strategy helps ensure you never miss a payment and allows you to establish a consistent payment history.
Monitor Your Credit Reports
Regularly checking your credit reports allows you to track the impact of your personal loan and spot any errors or inaccuracies. You’re entitled to a free credit report every week from each of the three major credit bureaus — Equifax®, Experian®, and TransUnion® — at AnnualCreditReport.com.
As you scan your reports, you’ll want to make sure your loan is being reported accurately and that your on-time payments are being recorded. If you notice any mistakes, dispute them with the appropriate bureau promptly.
The Takeaway
So, can a personal loan build credit? Yes — if managed properly, a personal loan can have a positive impact on your credit profile over time. It can do this by adding positive information to your payment history and diversifying your credit mix. If you use a personal loan to pay down credit cards, it can also reduce your credit utilization, which is also factored into your credit scores.
However, the opposite is also true. Late payments and taking on more debt than you can handle can hurt your credit profile instead of helping it.
Ultimately, a personal loan isn’t a quick fix for bad credit, but it can be a strategic part of your long-term credit-building plan. By borrowing responsibly and staying on top of your debt, you can use a personal loan to work towards a stronger financial future.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.
FAQ
Do personal loans raise credit scores?
If managed responsibly, a personal loan can have a positive impact on your credit file. When you make on-time payments, it adds positive payment history to your credit reports, which is a major factor in your score. In addition, a personal loan can improve your credit mix if you mostly have revolving credit like credit cards. However, if you miss payments or take on too much debt, it could negatively affect your profile and make it harder to qualify for credit with attractive terms in the future.
How long does it take to build credit with a personal loan?
How long it will take to start seeing credit impacts from a personal loan will depend on your current financial situation. At the earliest, adding positive information to your credit reports may be factored into your scores a month or two later. However, it can a few more months for any positive measures to make a noticeable impact. If you already have negative information on your reports, it could take a year or more to turn things around.
Is taking out a personal loan bad for credit?
Taking out a personal loan isn’t inherently bad for your credit. In fact, if you manage it wisely, it could positively impact your credit file over time.
When you first apply for any type of credit, you may experience a small drop in your scores due to the hard credit inquiry. However, this effect is only temporary. Ultimately, repayment behavior has the largest influence over scores. If you take out a personal loan and make regular, on-time payments, it could have a favorable impact your credit profile. Late or missed payments, on the other hand, can have a negative impact.
The key factor is how you manage repayment of the loan.
Which types of personal loans typically help build credit?
Any personal loan that reports to the major credit bureaus — Equifax®, Experian®, and TransUnion® — can help build credit. This includes traditional unsecured personal loans from banks, credit unions, or reputable online lenders.
If you’re starting with little to no credit history, you might look into a credit-builder loan. With this type of personal loan, you don’t receive funds up front. Instead, the lender puts your monthly payments into a savings account. When all payments are made, you can access the account. The lender will report your payment activity to one or multiple credit bureaus, which can help you build a healthy credit history.
How can I avoid hurting my credit with a personal loan?
To avoid damaging your credit with a personal loan, only borrow what you can afford to repay and be sure to pay on time every month (payment history is the biggest factor in your credit scores). Also try to avoid applying for multiple loans and credit cards in a short period of time, as it can lead to several hard inquiries.
When managed responsibly, a personal loan can actually have a positive impact on your credit profile over time.
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