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Dos and Don’ts of Using a Personal Loan to Build Credit


Building credit involves taking on some form of debt so you can pay it off and there’s more than one way to do it. Credit cards, for example, offer flexibility and convenience but they tend to come with high-interest rates. Taking out a small personal loan, on the other hand, could be better. Following some simple rules can ensure that you help rather than hurt your credit score. If you’re considering taking out loans then you may want to work with a financial advisor to make sure you have a full financial plan in place first. 

What to Make Sure You Do When Building Credit

When building your credit by taking out a personal loan you’ll want to make sure that you take certain actions to make sure your efforts are effective. First, you’ll want a financial plan and you’ll need to understand what credit score you’re aiming for. This can help you determine what type of account you need to open or how much money to borrow. Here are some of the other most important things to make sure you do.

Do Shop Around for the Best Rate

When you’re in the market for a personal loan, you don’t want to jump on the first offer that comes along. Even if the loan terms look appealing, you owe it to yourself (and your wallet) to see what different lenders are offering in terms of interest rates and fees. The lower these costs are, the more money you’re going to save in the long run.

Do Review the Terms of the Loan Agreement

Once your personal loan gets the green light, you’ll need to finalize the deal by signing off on the paperwork. This is not a step you want to rush through. It’s a good idea to carefully read over your loan agreement before signing on the dotted line. One thing to pay attention to is whether there are any penalty clauses, which could cause your interest rate to increase or alter another loan term.

Do Make Your Payments on Time

The factor that has the biggest effect on your credit score is your payment history. Even one late payment can be devastating. When you take out a personal loan, your lender will provide you with a detailed payment schedule and it’s critical that you stick to it.

If you think you’re going to be late at any time, it’s best to let your lender know immediately to minimize any potential damage to your score. While it will likely damage your credit either way, there is at least a chance it isn’t reported if the lender knows of your intention to pay and what is going on with your account. You never get that benefit if you neglect to communicate.

What Not to Do When Building Credit

Dos and Don'ts of Using a Personal Loan to Build Credit

When you’re building your credit it’s important to have a plan to follow. It can be very easy to fall off the wagon or to take an action that could end up hurting your credit if you’re not careful. Even well-intended activities can damage your overall goal. Here are some of the mot important things not to do when using a personal loan to grow your credit.

Don’t Go Overboard Applying for Loans

Thinking that you can up the odds of getting approved by applying with multiple lenders at the same time could be a serious mistake. Any time you apply for a loan, it shows up on your credit report as a hard inquiry and can cause your credit score to dip. Sticking with just one lender that you’re confident will approve your application can minimize the impact on your score. Be as selective as you can when it comes to choosing the what type of loan you’re applying for.

Don’t Borrow More Money Than You Need

Just because you’re approved for a $5,000 personal loan doesn’t mean you need to accept that much money. If you don’t need the loan for any other purpose than building your credit, you could be better off borrowing a smaller amount instead. That way, you still get the benefit of establishing a payment history without having a huge debt burden hanging over your head.

Don’t Run up Other Kinds of Debt

As you make payments on a personal loan you may see your credit score begin to improve. A better score can make you eligible for other types of credit. While it may be tempting to borrow even more, you could be putting your score in danger. Having multiple lines of credit that are close to their limits increases your credit utilization ratio. A higher debt-to-credit ratio can knock points off your score.

The Bottom Line

Dos and Don'ts of Using a Personal Loan to Build Credit

Getting a personal loan can be an effective way to improve your credit if you’re using it wisely. Making payments on time and holding off on multiple applications for credit can help boost your score. You shouldn’t borrow more than you can afford, though, and you’ll want to make sure you have stable income and money put away in the event of an emergency so that you don’t default as that could really damage your overall credit.

Tips for Building Credit

  • Building your credit is an important part of your financial plan. If you don’t have a financial plan created that you can follow then you may want to consider working with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now
  • If you’re looking to build your credit then it’s important that you first understand how your credit score works. Make sure you check out our guide to see what type of credit score you should be aiming for and how you can get there.

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