No Credit History? Should You Take Out a Small Personal Loan to Get Started?

Good credit is one of the primary foundations of a healthy financial life. 

If you’re just getting started on your credit-building journey, you may be wondering what kind of debt works well for first-timers who have less options than borrowers with better credit scores.

Personal loans are one of the many forms of debt people consider when looking for their first credit account. Here’s what to know about using a personal loan to build credit score.

Should I take out a personal loan to build credit?

In general, two qualities make a credit account a good option for someone who’s starting to build their credit history: 

1. Accessibility: To be viable, accounts would have loose enough eligibility requirements that people with no credit history can still qualify.

2. Affordability: These accounts also have low enough interest rates and fees that borrowers don't overextend themselves. If they’re too expensive, borrowers can miss payments and do further damage to their credit score.

Unfortunately, using small personal loans to build credit wouldn’t necessarily make much sense based on these requirements.

Personal loans are typically unsecured, which means lenders don’t ask for collateral. That makes them harder to qualify for than, say, a share secured loan, which requires borrowers to contribute funds to a locked savings account with the lender.

Personal loans are also a relatively expensive form of borrowing. The average interest rate on a two-year personal loan was 9.58% in Q2 2021. That adds up to roughly $823 in interest on an $8,000 loan in just two years, which means every dollar would cost more than $0.10.

There are less competitive and less expensive options, so taking out personal loans to build credit isn’t necessarily a safe bet for beginners.

Alternatives to personal loans

When you’re looking to open your earliest lines of credit, it can be helpful to diversify them across both types of credit: 

• Installment: These provide the borrower with a single lump sum upfront, which they then pay back plus interest in monthly installments (i.e. personal loans).

• Revolving: These provide the borrower with a line of credit they can draw on at will, pay back in installments and repeat as necessary.

The diversity of your credit accounts is called your credit mix, and it’s worth 10% of your FICO score. VantageScore scoring methods emphasize it more heavily and call your credit mix and experience “highly influential” to your score.

It can be smart to create a credit mix that includes a variety of accounts and both types of credit. For example, you might start with a secured credit card and a credit builder loan to cover both bases.

You can also start with one type of credit and expand into the other as your credit score increases. That can be a solid idea if you’re not in a rush to build credit and can afford to stick with a secured credit card for a year or two.

Here are some accessible and affordable alternatives to personal loans for people who have never had a credit account before (in both categories of debt): 

Secured credit cards

Secured credit cards require borrowers to leave deposits with their lenders, which usually set the credit limit for their account. Because they’re secured, lenders are typically more willing to provide them to unproven borrowers.

As you would with any other credit card, you can avoid accruing interest on your balances by paying off the statement balance each billing period. That way, the card’s interest rate (which can be quite high) becomes irrelevant.

Student credit cards

If you’re in college or under the age of 21, you may qualify for a student credit card. They’re generally unsecured and have better rewards for users than secured cards, including perks and offers like cashback for good grades.

You may be able to get by without having a credit score, but a verifiable income (to cover your debts) and a cosigner with good credit could be necessary to qualify. 

Credit builder loans

Credit builder loans are a lot like inverted personal loans. The borrower makes all their monthly payments upfront, then gets their funds at the end of the loan term (rather than the beginning). The borrower is then free to use the proceeds however they want, just like personal loan funds.

Because the loan proceeds are kept in a savings account with the lender during the life of the credit builder loan, the risk to the lender is minimal. As a result, they usually don’t bother to conduct a credit check. This makes credit builder loans available to anyone, even if they have no credit history. 

Here are few other credit builder loan benefits:

• They operate like a forced savings plan, with borrowers finishing with a nice chunk of change. 

• They often come with low monthly payments, so borrowers can spread them out over a longer period (benefitting their payment history).

• Their interest rates are relatively low, making them an affordable option.

Start building your credit history today

If you currently have no credit history, you don’t have to wait any longer to get started. 

The sooner you can open your first account, the better. Here are two reasons why: 

1. It takes a surprisingly long time to build credit history. You won’t be able to generate a FICO score for six months, and it often takes around two years to get to the point where you can qualify for the more competitive cards. That’s why it’s wise to build credit early (when there’s no rush), so you have it when you need it later.

2. The length of your credit history is one of the five primary factors in calculating your credit score. It’s worth 15% of your FICO score and is of roughly equal significance to your VantageScore.

If your credit journey includes credit card debt, consider using Tally to help manage it. If you qualify for a lower-interest line of credit through Tally​​†, you’ll only need to make a single monthly payment.

​​†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.