Taking out a loan, regardless of the type, is going to have an impact on your credit score. And whether it causes your score to go up or down is based on your decisions. If you've been considering an online loan, it's critical to understand how to leverage it to help you build your credit and avoid it causing your score to tank.
How Does a Loan Affect My Credit Score?
There are several actions you'll take over the life of a loan that could impact your credit score, either positively or negatively.
Shopping around and applying for loans
It's critical to see what options are available from various lenders. But you'll want to keep actual applications to a minimum. Window shopping to get prequalified results in a soft credit pull, which has no bearing on your score.
When you actually apply for online loans, it triggers a hard credit check which is reported back to the credit reporting agencies. Multiple hard credit checks are looked on unfavorably, so only apply for the 1-3 loans you really want.
Repayment
If payments are on-time and for the requested amount, you may see an increase in your credit score as a result. But if payments are late or missed, your score could suffer. Ensure the loan you agree to has payment terms that you're prepared to handle
Credit utilization and consolidation
Using an online loan for debt consolidation could decrease your overall credit utilization ratio (the amount of credit you're using divided by what's available). A lower credit utilization ratios can improve your credit score — experts tend to recommend limiting your credit utilization to 30% of your total available credit.
Choosing the Right Loan
When you're weighing options for personal loans, you'll want to consider:
- The terms: An online loan with a reasonable interest rate and low monthly installment payments is a great way to build your credit.
- Your credit mix: If you already have one or more personal loans, you may want to look at another option since credit mix is a component of your score. On the other hand, if you have credit cards but no personal loans, a loan will enhance your credit mix.
Alternatives to Loans
If you still want access to funds that will help build your credit, but the terms of a personal loan aren't the most favorable, there are other options.
- Look for credit-builder loans: These are loans designed to help people with limited or no credit history. Credit builder loans enable you to take out a small loan (often less than $1,000), which is set aside in a savings account or certificate of deposit while you make monthly payments with interest. These payments are reported to the credit reporting bureaus, and once you make all of the payments, you receive the lump sum.
- Consider a credit card: This could be a card that you qualify for on your own, or if you need support, being added as an authorized user by a family member. Either way, using a reasonable amount of credit on the card and making timely payments is going to work to boost your score.
The Bottom Line
Choosing an online loan you can comfortably make payments on could help to boost your credit score. But be cautious and make sure a personal loan is the right kind of debt before you commit. If you decide you may not be able to be successful in paying off the loan over time, it may be best to hold off on the purchase or seek out a credit-builder loan instead.
Notice: Information provided in this article is for informational purposes only. Consult your financial advisor about your financial circumstances.
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Original Source: Can an Online Loan Help You Build Your Credit?
