Hey there, let’s talk about a common question that comes up in the personal finance community. That question is, “Should I take out a loan to raise my credit score?”
Many people who have no credit history or a low credit score ask this question because they're told that one key way for raising their scores is by taking out a loan.
It's tempting to take on debt to prove you can pay it off. Your credit score is, in part, determined on your history of on-time payments, so if you don't have a history, how can you have a decent credit score?
Because of this, some people might want to take out a credit builder loan or a personal loan in order to build their history. But there are better ways to raise your ratings with the three credit bureaus, which I'll go over below.
What Loans Do To Your Credit Score
When you apply for a loan, you now have a debt in which you can pay consistent on-time payments in order to raise your credit score over time. This is true and will help improve your credit ratings, however in the immediate term, the following happens:
- Your interest rate and monthly payment may be high because of poor credit.
- You pay interest, which is money you’re essentially throwing away.
- You’ll pay fees to open the loan.
- High balances hurt your credit score and you'll also have a higher debt-to-credit ratio.
- Hard inquiries on your credit report to get the loan will hurt your credit score for a few months.
So what you've done is put yourself at risk because now you're in debt and you have to responsibly pay back the debt for the length of the terms, which is likely 3-5 years.
This risk is complicated by the fact that if you encounter a financial emergency, such as a job loss, an unexpected visit to the ER, or any other financial loss, you may have to use up some of the money that you borrowed.
If you use up the money you borrowed in order to cover your emergency, then it may be more difficult to pay the loan back. This puts you in a worse situation than you were originally.
Given the above reasons, it is generally a bad idea to ever take out a loan to raise your credit score. With that in mind, there are other ways to raise your credit score which doesn’t involve taking out a loan.
These other ways take time, but that's okay because these scores take time to increase regardless of what method you use!
Better Ways To Raise Your Credit Score
There are better ways to raise your FICO and Vantage credit scores. While it can take 18-24 months to see a significant increase, remember that you can’t game the system. It is designed to take time to raise your credit score.
With that in mind, patience and persistence is a virtue. As I go into below, using multiple methods over two years will help your credit score much better than applying for and taking out a loan which will simply put you in more debt.
Here are three ways to raise your credit score over 18-24 months.
Get A Secured Credit Card
A secured credit card uses an account in which you deposit money as collateral. This means you can use your secured credit card as you would any other credit card, but your credit limit would be based on how much money you have stored in the account being used as collateral.
Related Post: Credit Cards Facts That You May Not Know
This gives the credit card company security in that you will pay off your card or they can take the money from the account. If you have bad credit or no credit, a secured credit card is often a great way to build a credit history which will help your score.
This method also helps you control your spending in case you've been irresponsible with a credit card in the past. You'll only be able to spend at most the balance of your account, which will prevent you from drowning further in debt.
Find A Cosigner
If you cosign a credit card or loan with someone you know, such as a family member or significant other, your credit score will go up as they pay off their debts and/or loan. You would benefit from them paying their balance even if you don’t assist them in paying it.
You might think this is an easy way to improve your situation, but be warned, if the person you cosigned with stops paying their debts or fails to keep their payments on time, and those debts also have your name on them, you will be forced to pay the debts or your credit score will suffer greatly.
This is can be a risky approach if you don’t genuinely trust the person you’re cosigning with, or don’t mind paying your creditors in the event that they default.
In the end, this approach comes down to your comfort level.
On a personal note, I would only recommend this approach if you know that you can cover any debt on accounts in which you have a cosigner.
Pay Your Debts On Time
This is the easiest and most efficient approach to raise your credit score regardless of your situation or your credit history. Pay down your debts consistently month after month. Your on-time payment history will help you reach a good credit score.
Don’t be late and try not to take on more debt. It can take up to 2 years but whether you have no credit or bad credit, your score will start to look better.
Minimize Credit Utilization
You can also raise your score by minimizing your credit utilization. To do this, pay down your credit card debt and any other outstanding loans that you have. Even an extra $20 per month added on to the minimum payment of your credit card can go a long way as far as reducing interest payments.
Related Post: Crush Debt With As Little As $20 Extra Per Month.
Fix Errors On Your Credit Reports
You can check your credit report from the three credit bureaus here. This site allows you to get one free check per year from each bureau. If you find a mistake in any of your credit reports, then you can report it to the credit bureaus and get the mistake removed. This may increase your credit score.
Wrapping It Up
In the end, it’s generally a bad idea to take out a loan to raise your credit score. You would never want to risk lowering your scores even more due to having more debt or from missing a payment. Following the methods above should improve your scores over time, and this is the best way to do it.
If you are in debt and you're looking for ways to get out, pick up The Dollar Blogger's Money Mastery System. I will teach you how to get out of debt and save for your future, a dream vacation, car, and home.