How to Build Credit Quickly with Installment Loans
January 17, 2019 | By June Mckaig
Why is building credit important?
Well, think about this: you want to buy a car, but you don’t just have $25,000 sitting around waiting to be spent. So, how do you finance it? You will need to charge some of the amount to a credit card or take out a loan so you can pay it off over time, and in order to do either of these things, you must first have a reliable credit score. How do you build credit?
Well, it’s a cycle that feeds into itself, because you must use a credit card or take out a loan and responsibly pay it back in order to establish a credit history, which then translates to a credit score. Credit is important if you ever wish to own a home, a car, go to university, or accomplish anything that requires a large sum of money.
So, let’s talk about how to build that credit with an installment loan.
What Is an Installment Loan?
Installment loans are the loans you typically imagine when you hear the word “loan”. An installment loan is a sum of money that you take out on a loan, and agree to pay it back over a set time period with an agreed upon interest rate.
Typically, an installment loan’s interest rate will be lower than that of debts collected on credit cards, which can make them useful in transferring debt or managing a sum too large to pay off in only a few months. Some of the most recognizable types of installment loans include:
- Personal loans
- Car loans
- Student loans
How Can Installment Loans Build Credit?
Credit is typically based off of these items: new account activity, payment history, length of history, amounts owed, and diversity of accounts. Just by applying and taking out a loan, you begin your credit journey and tick off boxes in the ‘new account activity’ and ‘diversity of accounts’ categories.
When you use an installment loan and pay it off on time over time, you begin to create a profile for yourself that indicates you are a responsible borrower, which builds your credit score and opens doors to other lenders and larger sums.
How to Build Credit from the Start
It wouldn’t be a bad idea if you set your child on the credit path early, perhaps when they turn eighteen; or if you yourself have yet to begin that journey, to do so soon. So long as the party is responsible, it’s not a bad idea to start building credit both through small installment loans, and through credit cards—credit cards being a revolving line of credit, and therefore a plus towards the diversity of your debt.
By doing this, you start on the length of your history as a borrower with lenders who share your history with others and build your reputation as a reliable party.
How to Build Credit with Pre-Existing Debt
If you’ve already dug yourself into debt, it’s not the end for your credit score. In fact, depending on the nature of your situation, you might be able to utilize installment loans to build your credit back up!
Let’s say for example that you have quite the sum situated in student loans—student loans are notorious for having insane interest rates, which can make the process of paying them off seem impossible. Do a little research into a credible alternate installment loan with a lower interest rate to help yourself in the long run.
If you transfer your debt into that new loan and pay off the one with the higher interest rate, then you’ll have an easier time handling the money you owe, and build your credit in the process.
Credit Card Debt
The same can be said with credit card debt.
Credit cards work on a system of revolving debt, meaning that they have a range of credit to be used and must be paid on a flexible monthly requirement. If your credit score has taken a hit from outstanding debt on your credit card, then an installment loan can take some of that weight off and assist you in paying it off with smaller interest rates.
This would best be used in avoiding maxing out your credit card, which you’d want to avoid because it increases your credit utilization rate and significantly lowers your credit score.
Debt consolidation does hurt your credit score, albeit temporarily.
Since you are taking on more debt, you will go through a period of time when your score dips; however, if you pay off the loan within the agreed upon time responsibly, then your credit will be far greater than prior to your consolidation.
It’s vital to keep in mind that this method only works if you use the loan to retire existing debt as opposed to taking on more. Building your credit through installment loans has the potential of saving you money and your credit score in the long run.
Where to Start
The best place to start is by checking and seeing what your current credit score is. You should be able to access your FICO score through your bank, but you can also use online resources like Credit Karma.
After you’ve assessed where you stand, make a plan for yourself depending on the types of debt that you have, and make sure to vet the lenders you are considering before borrowing. Once you make your first inquiry, try to finish your search for a lender within 30 days, as all inquiries within that time period will be considered one hard inquiry.
If you do too many inquiries, it will reflect poorly on your credit score. Some details to consider when looking for a loan include:
- Loan amount
- Term length
- Interest and whether its variable or fixed
- Additional fees
Be diligent in your saving and spending wisely after making the commitment on your loan, and pay your bills on time and you’ll build your credit back up for your future purchases!