If you have a somewhat checkered credit history – or only have a limited history as a borrower – you may be wondering if it is possible to use a personal loan to establish 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 will likely be suspicious if you reapply.
This means that taking out a personal loan – or any other credit agreement – to build up your credit report is not a decision to be taken lightly.
Below we discuss:
Do loans affect my credit rating?
How any type of loan affects your credit ultimately depends on the borrower and how they handle it.
So, as long as you are sure you can afford the repayments, you can 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 usually less than 10% and decrease as you borrow money.
But first you will have to be accepted. This can be tricky if you have a spotty or no credit history.
So, before applying for any type of loan, it is worth using a free eligibility checker to find out if your application is likely to be accepted.
Remember that when you apply for a personal loan or a credit card, for example, lenders will do a “thorough search” of your credit report.
This takes the form of a thorough investigation of your finances and your ability to make repayments. And that search is saved to your file, which means other potential lenders can see it.
If you apply for too many personal loans and get rejected, it will negatively impact your credit score. Lenders may well think that you are desperate for money.
In contrast, eligibility checkers use “soft searches” of your credit report. These involve a less thorough investigation into your finances and also leave no trace in your file.
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Do student loans affect my credit rating?
Student loans do not work like ordinary personal loans.
Refunds only become due when you start earning above a specified threshold and the amount you pay is based on your earnings, not the amount of your debt.
Another important difference is that neither the debt nor your repayments are recorded on your credit report.
This means that your student loan will not affect your credit score. However, any default on student debt leaves a ‘footprint’, so you’ll have to keep paying back.
It’s 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 their affordability assessment.
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Does financing a car create credit?
Many drivers use personal loans or car financing from a dealership to pay for a new car.
When you apply for credit and a thorough search is done on your credit report, your score may drop a little.
However, it is likely to only be temporary. And as long as you’re on top of repayments, a car loan could help boost your credit score over time.
Read more: Best credit cards for credit builders
Does applying for a mortgage affect my credit rating?
When you apply for a mortgage, the lender will do a thorough search of your credit report to help determine whether or not to advance you money.
Even if the mortgage lender accepts your request, this search will still leave a mark on your credit report and lower your score slightly. However, once you make regular repayments, it will recover quickly and potentially increase.
Before formally applying for a mortgage, you can ask the lenders for a decision in principle.
It takes the form of a gentle search. This will give you a clearer picture of how much you can borrow and without any footprints that could lower your credit score and deter potential future lenders.
Read more: How to consolidate your debts with a credit card
Are there bad credit loans to help me build my credit?
You can check out credit cards or loans to rebuild your credit score.
If your priority is building or repairing your credit profile, not borrowing money, you may be able to improve your credit score or add a little more bulk to your credit report with a loan of credit enhancement.
Here you borrow a sum of money. But you can usually only access it once you have made all the agreed repayments and the debt is paid off. In this sense, a credit-generating loan works more like a savings account than a standard loan.
However, unlike the case where you make monthly contributions to a savings plan, because you borrowed money, each payment will be reported to credit reference agencies.
This allows you to use these monthly payments to boost your credit score and prove to lenders that you can handle your money well.
And once the loan is repaid, you will have a nice nest egg to deposit in a savings account.
If you’re considering a credit-building loan, however, it’s important to understand how it works and what you’ll be charged.
These loans can work in different ways. Some providers are free as long as you agree to open an account with a partner bank, while others charge interest or membership fees.
These are not consumer products available from major banks. You will usually only find them through specialized online lenders or credit unions.
Read more: How I paid off my £2,300 overdraft in six weeks
Credit generating credit cards
Another alternative is credit cards. These are for people with low credit scores who may have trouble getting standard credit cards or other forms of borrowing.
They offer a low credit limit, which makes it easy to pay on time and in full each month. As long as you pay your bill every month, your credit score should improve in four to six months.
It’s important to note, however, that if you miss a payment on any of these loans or credit cards, you’ll end up hurting your credit score even more.
Meanwhile, interest on credit cards is higher than on other cards. So your debt could skyrocket if you don’t pay your bill.
It’s also important to be picky about the loans you take out to build credit. Payday loans can be easy to find. But high interest rates mean you’re more likely to struggle with your repayments and further hurt your credit score.
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Can I apply for loans without affecting my credit rating?
Unfortunately, you can’t apply for a loan or any other credit arrangement without the lender doing a credit check first. This is because he needs to know how well you will be able to repay the money you borrow.
You can, however, find out if you’re likely to be accepted for a credit card or loan by using a free eligibility checker before you apply. These use gentle searches, which leave no imprint on your credit file.
This means that when you apply and a thorough search is done, you can be more confident that you will be accepted.