If you’re working to build or rebuild your credit history, you may want to think twice about using a personal loan to do it.
While plenty of lenders may be willing to work with your credit situation, you may have a hard time finding favorable terms. And if you’re not careful, you may find that the lender isn’t helping you build credit at all.
Here’s what you need to know about getting a personal loan to build credit, along with ideas for other ways to help strengthen your credit profile.
How a personal loan can help build credit
Making your loan payments on time can demonstrate responsible borrowing and may help improve your credit over time. In Canada, lenders that report to Equifax Canada or TransUnion Canada can contribute to your credit history.
A personal loan may help strengthen several areas of your credit profile, including:
- Payment history: Making every payment on time is one of the most important factors in building good credit.
- Credit mix: Having different types of credit, such as a credit card and an installment loan, can show you can manage different borrowing products responsibly.
- Length of credit history: Keeping accounts in good standing over time may strengthen your credit profile.
Applying for a loan may also result in a hard credit inquiry, which can temporarily lower your credit score by a small amount. For many people, the impact is modest and temporary.
Why a personal loan may not be the best choice
Although a personal loan can help build credit, there are situations where it may do more harm than good.
High interest rates
If you have limited credit or poor credit, you may only qualify for loans with higher interest rates or additional fees. Those costs can make borrowing much more expensive.
Missed payments can hurt your credit
Making payments on time is essential. Missing payments or falling behind can negatively affect your credit history.
Not every lender reports to credit bureaus
Before accepting a loan, ask whether the lender reports payment history to Equifax Canada and/or TransUnion Canada. If they don’t, your on-time payments may not help build your credit.
Short repayment terms
Some short-term loans require repayment quickly and can be difficult to manage if money is tight. If you can’t repay the balance on time, borrowing more to cover the debt can become expensive.
Alternatives to a personal loan
If your goal is simply to build credit, there may be other options worth considering.
Credit-builder loans
Some financial institutions and credit unions offer credit-builder loans specifically designed to help establish a positive payment history. These products typically hold the loan funds until you’ve completed your payments.
Credit cards
A credit card can also help build credit when used responsibly.
To get the most benefit:
- Make payments on time.
- Pay your balance in full whenever possible.
- Keep your balance well below your credit limit.
If you’re just starting out, a secured credit card may be easier to qualify for than an unsecured card.
Use your existing accounts
If you already have a loan or credit card that’s reported to Canada’s credit bureaus, simply using it responsibly may be enough to continue building your credit. You may not need to take on additional debt.
Bottom line
A personal loan can help build your credit if you make every payment on time and your lender reports your account activity to Equifax Canada or TransUnion Canada. However, high interest rates, fees, or short repayment terms can outweigh the potential benefits.
Before borrowing, compare your options carefully. In some cases, a credit-builder loan, secured credit card, or responsible use of an existing credit account may be a more affordable way to strengthen your credit history over time.