Should I get a personal loan to build credit?

If you have a somewhat chequered credit record – or you only have a limited track record as a borrower – you might wonder about using a personal loan to build your credit score.

The risk, of course, is that if you can’t manage the loan well, it will have the opposite effect on your credit score. Lenders are likely to be wary if you apply again. 

This means taking out a personal loan – or any other credit agreement – to build your credit record is not a decision to be taken lightly.

Below, we discuss:

• Do loans affect your credit score?
• Can you get a personal loan with a poor credit score?
• Does financing a car build credit?
• Fast credit-builder options

Read more: Best credit cards for poor credit

Do loans affect my credit score?

How any sort of loan affects your credit is ultimately down to the borrower and how well they manage it. 

So as long as you are confident that you can afford the repayments, you may want to consider using a personal loan to build credit.

Personal loans come with cheaper interest rates than other loans such as a credit card. They are typically under 10% and falling the more money you borrow.

But you will need to be accepted first. This may be tricky if you have a patchy or non-existent credit history.

So before you apply for any type of loan, it’s worth using a free eligibility checker to find out whether your application is likely to be accepted. 

Remember that when you apply to borrow money on a personal loan or credit card, for example, lenders will carry out a “hard search” on your credit file.

This takes the form of a thorough investigation of your finances and ability to make the repayments. And that search is recorded on your file, meaning other prospective lenders can see it. 

If you apply for too many personal loans, and are rejected, it will have a negative impact on your credit score. Lenders may well think you are desperate for the money.

By contrast, eligibility checkers use “soft searches” of your credit record. These involve a less in-depth investigation of your finances and also leave no record on your file.

Is it better to use an overdraft or credit card? We weigh up the pros and cons of overdraft and credit cards.

Will paying off a personal loan improve credit score?

If you’ve made your personal loan repayments on time, then these payments will have a positive impact on your credit score for 10 years or so.

But in the short-term, paying off a personal loan may cause your credit score to dip temporarily if that was the only loan or debt on your credit report. The credit agency Experian explains more about this.

Can you get a personal loan with a credit score of 550?

A credit score of 550 is generally regarded as poor. Credit agencies have different scoring systems, ranging from 0-1,000, but a score of 550 is universally viewed as needing improvement.

A poor credit score may make it harder to get a personal loan, but there should still be options for you.

Just be aware you may not be approved for a large loan, and you may have to pay a larger interest rate because you are deemed a higher-risk borrower.

Do student loans affect my credit score?

Student loans don’t work like ordinary personal loans.

Repayments only become due once you start earning above a specified threshold and the amount you pay is based on your earnings, not the size of your debt.

Another important difference is that neither the debt nor your repayments are recorded on your credit record.

This means your student loan won’t affect your credit score. However, any defaults on student debt do leave a “footprint”, so you would need to keep up the repayments.

It is also worth noting that if you were applying for a mortgage, the lender would ask you about all your debts – including student loans – as part of its affordability assessment.

Does financing a car build credit?

Lots of drivers use personal loans or car finance from a dealership to pay for a new car.

When you apply for any form of credit and a hard search is run on your credit report, your score might dip a little.

However, it is only likely to be temporary. And as long as you stay on top of the repayments, a car loan could help you build your credit score over time.

Does applying for a mortgage affect my credit score?

When you apply for a mortgage, the lender will do a hard search on your credit report to help it work out whether or not it should advance money to you.

Even if the mortgage lender goes on to accept your application, this search will still leave a footprint on your credit report and cause your score to drop a little. However, once you are making regular repayments, it will quickly recover and potentially go up.

Before you formally apply for a mortgage, you can seek a decision in principle from lenders.

This takes the form of a soft search. So you will get a clearer idea of how much you can borrow and without any footprints that could lower your credit score and deter potential future lenders.

The better news is if you succeed and get a mortgage, and keep up with payments, that has a positive affect on your credit score.

Loans to help build credit

You can look at either credit cards or loans to rebuild your credit score.

Credit-builder loans

If your priority is building or repairing your credit profile, not actually borrowing money, you might be able to improve your credit score or add a bit more bulk to your credit file with a credit-builder loan.

Here, you borrow a sum of money. But you can usually only gain access to it once you have made all of the agreed repayments and the debt is paid off. In this sense, a credit-builder loan functions more like a savings account than a standard loan. 

However, unlike when you make monthly contributions to a savings plan, because you have borrowed money, each payment will be reported to the credit-reference agencies.

This enables you to use these monthly payments to boost your credit score and prove to lenders that you can manage your money well.

And once the loan is repaid, you will have a nice nest-egg to pop into a savings account.

If you are considering a credit-builder loan, though, it’s important to understand how it works and what you will be charged.

These loans may operate in different ways. Some providers are free so long as you agree to open an account with a partner bank, while others charge interest or a membership fee.

These are not mass-market products available from high-street banks. You will usually only find them offered by specialist online lenders or credit unions.

Credit-builder credit cards

Another alternative is credit-builder credit cards. These are for people with low credit scores who may struggle to get standard credit cards or other forms of borrowing.

They offer a low credit limit, making it easier to pay on time and in full each month. So long as you clear your bill every month, your credit score should improve in four to six months.

It’s important to note, though, that if you miss a payment on one of these credit-builder loans or cards, you will end up doing further damage to your credit score.

Meanwhile, interest on credit-builder cards is higher than on other cards. So your debt could spiral if you don’t settle your bill at the end of each billing period.

It is also important to be picky about any loans you take out to build credit. Payday loans might be easy to come by. But high interest rates mean you are more likely to struggle with your repayments and damage your credit score further.

Can I apply for loans without affecting my credit score?

Unfortunately, you can’t apply for a loan, or any other credit agreement, without the lender running a credit check first. This is because it needs to find out how capable you will be of repaying any money you borrow.

You can, however, find out whether you are likely to be accepted for a credit card or loan by using a free eligibility checker before you apply. These use soft searches, which don’t leave a footprint on your credit record.

This means that when you do apply, and a hard search is run, you can be more confident that you will be accepted.