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Personal loans can be a useful credit-building tool so long as you pay them off the right way. Building a history of timely payments on your loan is key to improving your credit over time, so it may help to set yourself up for success with a fixed-rate loan that offers manageable payments.
Like credit cards, the payments you make on a personal loan are reported to the credit bureaus. Every month you pay your bill on time reflects positively on your credit report. Of course, having a strong history on one account may not improve your overall credit picture if you have other accounts with late or missed payments at the same time.
Credit is an essential tool in our daily lives, whether we like it or not. Your credit score impacts your approval odds of getting a mortgage, credit card or even renting an apartment. Simply put, a good credit score makes life easier, while bad credit has the opposite effect.
There are a few things to consider when comparing personal loans to help you build credit.
Unsecured vs. secured
Personal loans can either be secured, which means you pledge an asset as collateral (such as your car), or unsecured, meaning no collateral is attached to the loan. A secured loan is considered less risky to lenders, generally resulting in lower interest rates. Unsecured loans don’t require collateral but might have higher interest rates to compensate for the increased risk.
Fixed vs. variable interest rates
When comparing personal loans, it’s vital to understand fixed vs. variable interest rates. The interest on a fixed-rate loan stays the same during the life of the loan — making it easy to plan ahead since your payments remain stable. On the other hand, interest rates on a variable loan fluctuate based on current market conditions, which could lead to a sudden jump in your monthly payments if rates rise.
Repayment terms
You want to review the loan terms, including the repayment schedule and fees. It’s good to avoid loans that charge a fee for paying it off early, known as prepayment penalties. Understanding the terms of your loan will help ensure that you can consistently meet your monthly payments.
One of the main risks with any loan is not paying your bill on time. Missed payments can result in late fees, paying more interest, and negative marks on your credit report. The best way to mitigate this risk is to ensure the loan payments are manageable with your current cash flow.
If you have an unstable or irregular income that could impact your ability to pay on time, you might want to borrow less or reconsider your options. For example, extending the length of your loan will lower your payments and give you more time to pay off the loan. However, it could cost you more interest in the long run, so it’s about finding a balance you’re comfortable with.
Personal loans are a convenient way to spread out the costs of large purchases while building credit at the same time. Fixed-rate loans offer manageable payments that can help you achieve your goals, but be sure to shop around for a fair rate and review the loan terms to find the right fit for you. Above all, choose a loan you can afford, never miss a payment, then watch your credit improve slowly but surely.
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