How to rebuild your credit after taking a bad credit loan

Sometimes circumstances mean you need to use a bad credit loan to deal with an emergency or meet a financial goal. It's better to use a less-than-perfect tool to solve a problem than to not address the problem at all.

Your bad credit loan could be more than a tool for meeting a financial goal, however. It could be part of a strategy to meet your credit score goals, too. 

Consistent, on-time payments of your bad credit loan could go a long way toward helping you boost your score—opening up better loan terms and more financial opportunities. Here's how to build your credit after taking on a bad credit loan.

Freedom Debt Relief is not a credit repair organization and does not provide or offer services or advice to repair, modify, or improve your credit.

How a bad credit loan affects your credit score

In the short term, a bad credit loan doesn’t impact your credit score any differently than a loan that requires a higher credit score. Loan interest rates don’t appear on your credit report, so lenders that run your credit won't automatically know that you have a bad credit loan.

The short-term impacts from opening a new loan could include: 

• Credit inquiry. Lenders check your credit using a hard inquiry when you apply for a personal loan, and this could cause a small drop in your FICO credit score for up to a year.

• Revolving utilization. If you used the bad credit loan to consolidate credit card debt, the change in credit utilization (how much of your revolving credit you're using) could help your credit score. 

• Average account age. Taking out a new loan drops the average age of all of your accounts, which could harm your credit until your accounts get older.

The main difference in how a bad credit loan could impact your credit score will be seen in the long term. That's because loans with higher interest rates tend to have higher monthly payments, which means more of your income is going to debt. This increases your debt-to-income ratio (DTI), and could make you more likely to miss payments or fall behind.

Ultimately, how you manage your loan will determine the overall impact to your credit scores. Keep up with consistent financial habits, like paying on time, and your credit score could grow quite a bit in the long term. Here are some of the potential long-term impacts:

• Payment history. Each on-time payment could be a stepping stone to better credit; the longer you go without missing payments, the better your credit score could look. 

• Account history length. The older your loan gets, the better it could be for your average account age. Plus, accounts closed in good standing stay on your credit report for 10 years, potentially giving a healthy bump to your credit scores for years to come. 

• Account balances. If you keep your credit card balances low and avoid taking on new debt, your credit score could grow stronger as you pay down your loan balance. 

How soon can you start rebuilding credit? 

You could start rebuilding credit soon after you take out your loan. Having a bad credit loan doesn’t have to stand in the way of your financial goals going forward. On the contrary, it could even help you with money goals, like building a good credit score for your next personal loan. Here’s what to do:

• Set up your bills (including your bad credit loan) on autopay so you never miss a payment.

• Avoid taking on more credit card debt, even if it means not using your card for a while.

• Look for ways to pay down any remaining credit card debt even faster, if you can. 

• Don’t close your old credit cards (unless they have fees) so your average account age and available credit don't drop. 

• Avoid opening any new credit cards or loans until you’re back on track with your credit. 

• Check your credit score updates on a monthly basis to make sure you’re still moving forward. 

• Check your credit report at least once a year to make sure everything’s correct. 

Tips for getting past a bad credit loan

The interesting thing about credit is, it’s never just about your credit score. Credit is a part of your overall financial picture. And the things you do to improve your overall financial health could make it easier to build good credit, too. 

Here are some tips on shoring up your big financial picture:

• Stay positive. We all have setbacks, and that’s completely normal. The key to moving past them is knowing you have the power to change things, even if it takes a little time. You’re stronger than you think.

• Budget for the win. Budget is a scary word to some people. Instead, think of it as a spending plan. You get to tell your money where to go, not the other way around. Building a budgeting habit could help you make sure you spend your dollars wisely. 

• Pay more than the minimum. Credit card minimums aren't designed to pay off your cards quickly. Even a few extra dollars over your minimum payment could help you pay down the balance faster. 

• Boost your income. Even though you’re busy, if you can find small ways to earn more, you could have more money to save or pay off debt. The world is full of small side hustles, or you could consider bigger changes like a career switch.

• Build an emergency fund. Lots of people rely on debt when emergencies strike, and that could set back your progress. You could get ahead by saving up before the emergency happens. Focus on creating savings habits, a little at a time. Even $5 a week adds up to a decent amount over a few months. 

Celebrate progress and stay consistent

Life is a journey. We all go through different phases, and that also applies to your financial life. Sometimes that means having a great credit score, and sometimes it's a work in progress. No matter where you are now, you don’t have to stay there. 

Build some small habits that’ll carry you closer to your goals. That could be learning how to rebuild your credit after a bad credit loan or even buying a home for your family.