Can I build credit with a personal loan?
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UPDATED: Oct 26, 2012
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Yes, a personal loan can build credit for borrowers with poor and nonexistent credit scores. Various types of financing can build up credit scores if borrowers are responsible about repaying their debts.
Many people have poor credit scores due to past mistakes with debt. Finding a personal financing lender is the first step in rebuilding credit.
Borrowers can improve their chance of selecting a good lender by evaluating and comparing different types of financial institutions. Obtaining financing from a credit union may be better than borrowing from a bank since credit unions typically offer lower interest rates.
When selecting how much to borrow, consumers should be cautious about borrowing too much. Lenders and credit monitoring agencies will be far more impressed with a borrower who makes on-time payments on small or medium amounts of debt as opposed to a borrower who took out massive amounts of money and failed to make the minimum monthly payments.
Making necessary payments on a personal loan builds up credit by showing lenders that a person is responsible. On the other hand, failing to make payments on debt—including personal loans—is a sure way to damage a credit score.
Applicants have some flexibility in selecting personal financing which comes in one of two forms.
In one form, they are secured. This means the borrowed money is literally “secured” by a borrower who offers up collateral. Collateral is any asset of value, such as a car or a home. For example, a borrower would approach a lender and offer up a home as collateral in exchange for a $100,000 loan. In the event that the borrower is unable to repay the loan, the lender can repossess the home and resell it in order to make up for the lost money.
The second form of personal loans is unsecured. As the name implies these loans are not secured by collateral. However, since no collateral is offered the interest rate on this financing is appropriately high in order to compensate for the increase in risk.
After taking these factors into account, borrowers should be able to decide if building credit via a personal loan is the wisest choice for individual circumstances. More information about personal lending can be found in our articles, other FAQs, and recent news stories.