Borrowers can use a small loan to build credit by making on-time payments and ultimately paying off the balance in full. At first, bad credit borrowers may only qualify for low loan amounts with higher interest rates, but by paying off loans and maintaining healthy financial habits like keeping credit utilization low, borrowers can improve their credit score and qualify for a better loan next time. In fact, improving your credit score can come with great benefits like faster loan approval, higher loan amounts, lower interest rates, and more!
Understanding Credit Scores
Your credit score is a three-digit number that major credit bureaus, lenders, and other financial institutions use to gauge how financially responsible you are. Consumers with a higher credit score are typically viewed as less of a financial risk and are, therefore, more likely to receive lower interest rates, higher loan amounts, and other perks. Credit score ranges include:
- 800 – 850: Excellent credit score
- 740 – 799: Very good credit score
- 670 – 739: Good credit score
- 580 – 669: Fair credit score
- 300 – 579: Poor credit score
While percentages may vary depending on the credit model you use (FICO, VantageScore, etc.), your credit score is determined using data from the following categories:
- Payment history (35%): How on-time you are with making your due payments on bills, loans, and other financial responsibilities.
- Amounts owed (30%): How much debt you currently owe.
- Length of credit history (15%): How long you have had open and active financial accounts.
- Credit mix (10%): The different types of financial accounts you have (loans, credit cards, investments, etc.)
- New credit (10%): How often you apply for new loans or lines of credit.
What are Small Loans?
Just about any loan that comes with a relatively low loan amount can be referred to as a small loan. However, it’s important to note that not all small loans will be helpful when it comes to improving credit history.
Some popular types of small loans include:
- Personal loans: Personal installment loans are one of the most versatile loan types. They can be obtained in varying amounts, with flexible terms and competitive rates, making them ideal for building credit. Borrowers can find personal loans through banks, credit union organizations, or online lenders.
- Credit-builder loans: Many types of personal loans can be used as credit-builder loans. Since credit builder loans are designed for borrowers working to improve their credit history, loan amounts typically remain lower, and rates may be higher, but usually not as high as quick cash loans like payday loans.
- Payday loans: Payday loans are quick and easy to get but may not be the best option for credit builder loans. Unlike traditional personal loans, payday loans come with extremely high interest rates and short repayment terms. Unless you can fully repay your balance in about two weeks or less, payday loans can end up making your financial situation worse.
- Short-term secured loans: Short-term secured loans, like car title loans, are similar to payday loans in that they come with high rates and short terms. Furthermore, borrowers risk losing whatever property they use as collateral should they default or miss payments on their secured loan.
Benefits of Small Loans for Credit Building
What are the benefits of using a small personal loan to build credit? As borrowers make monthly payments to pay off their small loans, credit bureaus will take note of this behavior for upcoming credit reports. Since payment history is the most impactful factor that affects your credit score, making all your payments on time will help you build credit. Furthermore, your small loan can help diversify your credit mix, which will also benefit your credit report.
After you pay off your small credit builder loan and continue to practice healthy financial habits, you may start to see your credit scores improve over time. This improvement can bring on benefits like:
- Higher loan amounts
- Lower interest rates
- More flexible loan terms
- Faster loan approval
Applying for Small Loans
So, how does using personal loans as credit builder loans work? Many lenders, including banks, credit unions, and other direct lenders, have online applications where borrowers can apply for funding. Qualification requirements may differ depending on the type of loan (traditional loan, payday loan, etc.) and lender you go with, but most will at least want to confirm that you have a steady source of income so you can repay your loan. Other information lenders may require include:
- Government-issued photo ID (Driver’s license, state ID, etc.)
- Bank account information (So the lender can verify income and send approved funds to your account via direct deposit)
After you complete your loan application and receive approval, the lender will send you a loan contract to read over. This contract will have all the information related to your loan, including interest rates, fees, repayment terms, and your loan amount. Read over the agreement carefully, and if everything makes sense, go ahead and sign the contract. At that point, you can expect to receive your approved cash shortly!
Managing Small Loan Repayments
Staying on top of your personal loan repayment will be key if you want to use your loan as a credit builder loan. Check out some tips that can help you manage your personal loan repayment below:
- Set up payment reminders: If you manually submit your payments, set up an alarm or alert on your phone or computer to notify you when you need to make a payment.
- Sign up for autopay: With autopay, monthly payments will be automatically deducted from your bank account on their due date. That way, you don’t have to remember to manually submit each payment.
- Plan your payments beforehand: If your loan has fixed interest rates, you should be able to plan out your payments from start to finish. Financial planning and budgeting will help make your loan repayment seamless and stress-free.
Common Mistakes to Avoid With Personal Loans
Just as loans can help build credit when used responsibly, they can also cause credit to drop when borrowers don’t prioritize repayment. Some common mistakes you’ll want to avoid when using a small loan to build credit are:
- Making late payments: Payment history is the most impactful factor on your credit report. Just one missed payment can negatively impact your credit for up to seven years! Avoid making late payments by signing up for autopay or setting up a reminder for yourself so you never miss a due date.
- Borrowing too much: Remember, when you pay back your loan, you repay your total balance, plus interest and fees. When shopping for a loan, make sure you can afford to repay your loan, plus interest, so you don’t fall off track and risk missing a payment.
- Not reading your loan contract: Before you sign, read over your loan agreement carefully. If everything makes sense, go ahead and sign. If not, make sure you talk to a loan agent for the clarification you need.
- Not asking for help when you need it: If you feel like your loan payments are becoming overwhelming, talk to your loan agent before things get out of hand. Your lender may be able to help make your loan more affordable!
Alternatives to Small Loans
Loans aren’t the only way consumers can work on building their credit. Some alternatives to small loans that can help consumers improve their credit scores include:
- Secured credit card: A secured credit card allows borrowers to open a credit account backed up by a cash deposit.
- Become an authorized user: Becoming an authorized user on a credit card will grant you access to a credit limit and benefit your credit mix without being responsible for repaying the balance.
- Practice healthy financial habits: Seek out non-loan alternatives to pay for your expenses so you can avoid unnecessary credit inquiries and prevent yourself from accumulating more debts.
Build Credit With CreditNinja Loans
Small credit builder loans can be a great financial tool for consumers looking to improve their credit scores. By prioritizing payment history and ultimately paying off the personal loan balance, consumers can start building credit that can bring on great benefits later on. If you’re looking for a credit builder loan that comes with competitive rates, flexible terms, and same-day funding, try a CreditNinja personal loan!* We specialize in bad credit personal loans, which means all credit types are welcome to apply. Check out our easy online application to see how much cash you could get today!
