How to Improve Your Credit Score with an Installment Loan

Many people underestimate the role that a good credit score can have not only on their purchasing ability, but on their overall financial health and well-being. Your credit score, often referred to as your FICO score, falls within a range of 300 to 850. And, the higher the score, the better. 

A good score is typically considered one that is over 700. When your score is 700 or over, you can borrow more money at a lower interest rate and have more flexible overall loan terms than with a lower score. But what happens when you have a poor credit score? If that’s the case, you’ll join the ranks of four in five Americans actively taking steps to improve their score. And one of the ways you can do this is with an installment loan. Effectively managing and paying toward your installment loan can improve your credit score, and fast!

Understanding Your Credit Score 

Before we discuss the specifics of an installment loan and how it can help, let’s ensure you understand your credit score. As we said above, your credit score—aka your FICO score—falls between 300 and 850. You start building a credit score around age 18 when you apply for your first loan or credit card. 

Your credit score is influenced by five primary factors. They are:

• Payment History (35%): This is the most influential component of your credit score. It shows whether you've made your loan payments on time. Late payments seriously impact your credit score, and the impact is as big as 100 points or more. Defaults and bankruptcies are also bad and will stay on your credit report for seven years.
• Amounts Owed (30%): Credit utilization measures how much of your available credit you are using. Lower credit utilization can be seen as evidence that you are handling credit responsibly and not overextending yourself.
• Length of Credit History (15%): This considers the age of your oldest credit account, your newest credit account, and the average age of all your accounts. Older credit histories are looked at more favorably as they demonstrate long-term financial stability and responsibility.
• New Credit (10%): This factor looks at how many new accounts you have opened and how many hard inquiries (when a lender reviews your credit due to a loan or credit card application) have been made on your credit report recently. Opening several new credit accounts in a short period can be seen as risky, potentially lowering your score.
• Credit Mix (10%): This refers to the variety of credit products you have, including credit cards, installment loans, finance company accounts, mortgage loans, etc. A diverse mix of credit products can have a positive impact on your score, indicating you can handle various types of credit. And, according to Experian, one of the three big credit bureaus in the United States, your mix should include both revolving and installment credit.

Selecting the Right Installment Loan

Now that you know what goes into your credit score, let’s talk about how an installment loan can help. First, as you saw above, new credit can help your score. If you haven’t applied for new credit in a while—at least six months—applying for a new loan can actually provide you with a slight improvement to your score.

Further, making on-time payments on that installment loan each month can greatly impact your score—and in a big way. As we shared, making on-time payments represents 35% of your credit score. So, every time you make that minimum—or higher—payment on time, give yourself a little pat on the back.

But, not all installment loan lenders are the same. You must do some homework to find the one that works best for your needs. Here are some things to help you get started.

Considerations When Choosing an Installment Loan

Here are some key factors to consider when choosing an installment loan.

Interest Rates and Terms

The interest rates and terms offered are big factors. A lower interest rate can significantly reduce the total amount you pay back, while favorable terms, such as a longer repayment period, can make monthly payments more manageable. 

Compare different lenders to find the best rate. Read the fine print to understand any additional costs that could affect your total loan costs, such as origination fees or prepayment penalties.

Lender Reputation and Loan Fees

Choosing a lender with a good reputation for customer service and ethical practices is a must. Research lenders online, read customer reviews, and check their status with the Better Business Bureau. 

Additionally, be aware of the loan fees. Some lenders charge application fees, late fees, or early repayment fees. Understanding these fees can help you avoid unexpected costs and choose a lender that offers the most transparent and fair terms.

How to Find a Loan That Matches Your Credit-Building Needs

There are also some things to be on the lookout for when choosing an installment loan to ensure you find the best lender to help you improve your credit score. 

Assess Loan Amounts That You Can Comfortably Repay

One of the keys to using an installment loan to improve your credit score is making consistent, on-time payments. Assess your budget to determine what monthly payment amount you can comfortably handle without straining your finances. Borrowing an amount that fits comfortably within your budget reduces the risk of late payments, which can damage your credit score.

Look for Loans with Reporting to All Three Major Credit Bureaus

To ensure your installment loan payments improve your credit score, verify that the lender reports to all three major credit bureaus: Experian, TransUnion, and Equifax. Regular reporting of your on-time payments can positively impact your credit history. 

If a lender does not report to these bureaus, your timely payments will not benefit your credit score, negating one of the primary benefits of taking out the loan.

Using Installment Loans to Build Credit

Though an installment loan can help you build your credit, it’s important to understand the responsibility that comes with financial borrowing. Here are a couple of things to remember before you apply for an installment loan so that you don’t inadvertently create more harm than good. 

Strategic Borrowing

Only borrow what you need and what you can realistically afford to repay. This approach prevents financial strain and contributes to a positive payment history. By managing your installment loan responsibly, you demonstrate reliability to lenders, which will be reflected in your credit score.

Payment Strategies

Setting up automatic payments is a wise strategy to ensure you never miss a payment. This helps maintain a spotless payment record, which is a must for your credit score, and reduces the hassle of remembering due dates. Additionally, if you can, make additional payments toward the principal amount. This shortens the loan term, saves on interest, and improves your credit utilization ratio faster.

Monitoring and Understanding the Impact on Your Credit Score

Most lenders report financial activity to the credit bureaus every month. This means that your credit score is always changing. For that reason, you want to check your credit score regularly to ensure that it is moving in the right direction and that there are no surprises along the way.

Regular Credit Monitoring

Monitoring your credit score regularly is a must to understand how your financial behaviors affect your score. It’s not a one-and-done thing, as your credit score always changes. Many free tools and services, such as credit report sites and apps, help you keep track. 

Additionally, your primary bank or credit card issuer might offer free access to your credit score. It's also important to check your credit report at least once per year to ensure accuracy and spot potential fraud. You can obtain your annual free credit report from one of the credit bureaus or through AnnualCreditReport.com, the only site federally authorized to provide these reports (aside from the credit bureaus).

Analyzing the Impact on Your Credit Score

Remember that every on-time payment can improve your score, while late payments can cause significant damage. Review the updates on your credit report regularly to analyze how your installment loan affects your credit score. 

If your score is not improving as expected, consider adjusting your borrowing and payment strategies—perhaps by increasing payment amounts or paying more frequently—to positively influence your credit score.

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