How To Use A Personal Loan To Build Credit From Scratch

Lenders have limited credit information about the credit history of the applicant in case of a “Thin Credit File”. This can be due to less number of credit products or new entry to the credit ecosystem. Lenders may find it difficult to assess the risk for high-ticket loans for such applicants, especially when it comes to big-sized unsecured personal loans.

A “Zero Credit History” is a situation where an individual has never availed a credit product at all. Lenders cannot assess the risk of lending for such applicants.

In both these cases, there is very little or no credit record of the customer with the credit bureaus and hence no method to assess the risk. It leaves them eligible for only a few offers that carry stringent loan terms and high interest rates.

Applicants having a minimum CIBIL score of 760 have very high chances of getting their personal loans approved. Borrowers with lower credit score or no credit score can also get their loans approved but at stringent terms and higher interest rates.

Yes, a personal loan can help new-to-credit customers to build their credit. Here’s how:

• Making timely repayments increases your credit score.
• Lowers your credit utilization ratio by consolidating multiple debts.
• Diversifies your credit mix and increases your credit score if managed well.

Your credit report includes the "All Accounts" section that shows the list of all credit products you have availed.

This section contains the details of all personal loans you've taken. Loan details for every loan account such as the loan status (active/closed/settled), sanction amount, outstanding, sanction date, etc. is mentioned in the report along with the DPD, which contains the repayment details for the past 36 months.

"0" in DPD entries signify that all EMIs were paid on time, while any other number indicates the delay in repayment.

The Role of EMI Payment History in Your CIBIL Score

• Your EMI repayment history is one of the key factors influencing your CIBIL score.
• Timely EMI payments demonstrate financial discipline and help strengthen your credit profile, whereas missed or delayed repayments can negatively impact your score.
• Once all EMIs are repaid successfully, your loan account is marked as “closed,” and this status is updated in your credit report by the credit bureaus. Your credit score improves, thereby, increasing your chances to secure loans in future.
• When unpaid EMIs are resolved through a settlement with the lender, the account is marked as “settled” instead of “closed.”
• A “settled” status can significantly lower your credit score and may reduce your chances of getting loans or credit cards in the future.

While credit cards may require stringent approval requirements, consumer durable personal loans and small-ticket personal loans do not require a borrower to adhere to tough approval requirements. In these scenarios, getting a personal loan can be beneficial.

Even though FD-backed credit cards are easy to secure, first-time borrowers may get overwhelmed in using them prudently and upon making mistakes, can lead to a negative impact on the credit score.

However, individuals may opt for either of the two depending on their requirements.

CIBIL score is calculated based on the following factors:

• Payment History - Your repayment history is the most crucial factor in calculating the CIBIL score. It includes the payments of your EMIs and credit card bills, and missed EMIs, if any.
• Credit Utilization Ratio - The credit utilization ratio refers to the credit limit being used by the individual against the overall approved limit. A low credit utilization ratio indicates responsible credit management and positively impacts your credit score.
• Credit Mix - Having a mix of various credit products and managing them well depicts your financial behaviour and plays an important role in enhancing your credit score.
• Length of Credit History - A longer credit history provides sufficient information to the lenders to assess the credit behaviour of the applicant, thereby, impacting your credit score considerably.
• Multiple Loan Applications - With every new loan application, lenders conduct a hard enquiry that can negatively impact the credit score. Therefore, it is advised not to apply for multiple loans in a short span.

• Start with small-ticket personal loans.
• Make repayments regularly without fail.
• Do not settle your account and aim for closing it.
• Verify the loan is marked as “closed” during loan closure and collect the NOC.

How Long Does It Take to Build a Credit Score with a Personal Loan?

It usually takes around 6 months to build your credit score after consistent EMI payments. Apart from making timely repayments, avoid multiple loan applications while building your credit score initially.

Which Type of Personal Loan is Best for Building Credit?

The below-mentioned personal loans are the best for building credit:

Credit Builder Loans

• These are loans with smaller loan amount designed to improve the credit profile of the first time borrowers.
• In this the loan amount is not disbursed but held in a secured account.
• The borrower makes the repayments and the repayment behaviour is reported to the credit bureaus.
• Once the repayments are completed the borrower receives the loan amount.

Small Ticket Personal Loans

• Small ticket personal loans are smaller loan amounts of up to Rs. 1 lakh.
• First-time borrowers are usually offered these loans for very short repayment tenure at a higher interest rate due to the high risk involved.

The timely repayments are reported to the major credit bureaus that builds a healthy credit profile.