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Which Loan Is Best for Building Credit?

Ben Luthi
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Quick Answer

If you have a limited credit history, a credit-builder loan may be best for building credit. In general, any loan with payments that are reported to the credit bureau will be equally effective for building credit, including auto loans, mortgage loans, student loans and personal loans.
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Building credit can be a lengthy undertaking, so it's natural to look for opportunities to speed up the process. One question you may have is whether the types of loans you're using matter when building credit.

While the types of loans you have may come into play with your credit score, it's not nearly as important as how you manage your credit accounts. Read on to learn how loans impact credit, which ones can help you build credit, and what matters most when it comes to achieving a high credit score.

Does the Type of Loan Matter for Building Credit?

There are many different kinds of loans you can use to build credit. You can use a revolving credit line like a credit card or installment loans, such as auto loans, mortgage loans, student loans, personal loans, credit-builder loans and more.

But do some loans do a better job of building credit than others? It can depend on a few factors. If a lender reports your loan payments to all three credit bureaus (Experian, TransUnion and Equifax)—and you make all your payments on time—this can help your credit scores across the board. But because lenders don't always do that, you could have a loan that is helping your credit score based on the information in one of your credit reports but is doing nothing for a score based on a different report. This doesn't depend on the type of loan but rather on the lender itself. Additionally, certain types of loans, such as payday loans and pawn loans, typically don't report payments and thus won't do anything to help your credit.

The bigger consideration is whether you can qualify for loans that can help you build credit. Some loans may be more accessible than others if you have a limited credit history or your credit score is low.

For example, you may have a hard time getting a mortgage loan or an affordable auto or personal loan if you've had credit problems in the past or have a thin credit file with few or no accounts. But if you're a college student, you don't need a credit history to obtain federal student loans—and your student loan can help you build credit as well as any other type of installment loan. Additionally, there are secured credit cards and credit-builder loans that are designed specifically to help those with little credit establish a positive credit history.

It's important, however, to note the difference in how credit cards and installment loans work.

With a credit card, your credit utilization rate—the percentage of your credit limit that you're using at a given time—is an important factor in your FICO® Score☉ , which is the score used by 90% of top lenders.

Utilization rate doesn't come into play with installment loans, but FICO does consider how much you owe on this type of loan. Still, playing down a large chunk of credit card debt could have a more significant positive impact on your credit score than making a large payment on an installment loan.

If you don't have a high utilization rate to begin with, there isn't a huge difference between the two types of credit in terms of how they can help improve your credit score.

The Factors That Can Help (or Hurt) Your Credit Score

When calculating credit scores, FICO looks at five factors—and it's these factors that you'll want to focus on as you work to build your credit history.

  • Payment history: This is the most important factor in your FICO® Score and considers whether you pay your bills as agreed. Paying your debts on time every month is the most important thing you can do to build a positive credit history, while missing payments can do the greatest damage in the shortest time frame.
  • Amount owed: This important scoring factor is based on the total dollar amount of all outstanding debts, as well as your credit utilization rate on revolving credit accounts. The more debt you have, the harder it may be to keep up with payments. Also, a high utilization rate could indicate that you're having a hard time managing your finances without debt. You should always aim to keep your utilization on credit cards below 30%, but the lower, the better. Those with top credit scores tend to have utilization rates under 10%.
  • Length of credit history: This factor considers how long you've held your various credit accounts. Length of credit history is defined as the age of your oldest account plus the average age of all open accounts. The longer you've managed credit, the better it is for your credit score. Opening new accounts frequently can reduce the average age of your accounts.
  • Credit mix: This factor considers the different types of credit you use. Showing you can responsibly manage a diverse mix of accounts, such as credit cards and installment loans, could help your credit score. That doesn't mean you should start applying for different loan types to improve your credit mix. According to FICO, this factor likely won't impact your chances of obtaining credit, but it can be helpful as you try to increase your credit score to the highest level possible.
  • New credit: Virtually every time you apply for credit, the lender runs a hard inquiry on your credit reports; this can have a slight, temporary negative effect on your score. Hard inquiries remain on your credit reports for 24 months but only impact your FICO® Score for 12 months. It's best to avoid applying for multiple credit accounts in a short period of time, which can have a negative compounding effect on your credit score. The one exception is when you're rate shopping for a loan such as a mortgage or auto loan; if you apply within a two-week period, the credit scoring models will count those inquiries as just one.

Use Other Monthly Bills to Help Boost Your Credit Score

Traditionally, using revolving credit and installment loans has been the primary way to build credit. But with Experian Boost®ø, you can also use utility bills, phone bills and popular streaming services to increase your FICO® Score.

With Experian Boost, you'll connect your accounts to the bank account you use to pay your bills, then Experian will identify eligible on-time payments. You'll be able to choose which ones you want to have added to your Experian credit file.

Once you confirm, if the positive payments can help increase your FICO® Score, you'll see the change immediately.

Throughout the credit-building process, it's important to monitor your credit regularly, keeping an eye on your credit score and credit report. Doing this will help you keep track of your progress and spot opportunities to make improvements along the way.

How Good Is Your Credit Score?

Examples: 600, 700, 780, 803
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