It can be difficult to repair your credit from damage, but it could potentially save you thousands of dollars per year to improve your score. That’s because bad credit borrowers pay significantly higher interest rates on their mortgage, auto, and other loans. Some people with bad credit or no credit history may not even be approved for a loan in the first place, which makes it tough to get ahead financially. And it’s a common problem; more than one-third of Americans fall into the subprime credit bracket, according to a 2019 Experian study.
Luckily, there are ways to raise your credit score, even if your credit has been destroyed or you have yet to establish a credit history. Most people don’t think about their credit until they need to borrow, but if you develop a plan to build credit now, you’ll be in a much better position when an emergency arises or when you’re finally ready to buy your first home.
Before you take out a loan to help you build credit, you should get a copy of your free credit report from AnnualCreditReport.com to ensure there are no errors. Common issues include accounts that aren’t yours, inaccurate reporting of delinquencies, and missed payments older than seven years. Be sure to dispute any errors before applying for a loan to build credit.
Positive payment history can help your credit profile. Loans could be a useful tool to help build your credit history but borrowers need to make sure that their lenders report payment history to credit bureaus and then, the most important part, borrowers should make payments on time. That’s why it’s always critical to never borrow more than you can afford to repay at the rates and terms being offered.
Use a Credit-Builder Loan
You can get approved for a credit-builder loan even if you have no credit, but you will need to prove you have enough income to make the payments. Credit-builder loans are typically available through community banks and credit unions and are often dubbed “Fresh Start Loans” or something similar. You might also find credit-builder loans at Community Development Financial Institutions, which are geared towards assisting low-income communities, and there are even a few online lenders that offer credit-builder loans.
With a credit-builder loan, you won’t get the money right away. Instead, the cash is held in a bank account until you’ve entirely repaid the loan. So if you need access to cash while you build credit, this isn’t an option for you. It’s also not a good idea to use a credit-builder loan if you have existing debt; you’re better off devoting your income to paying off the balance you owe. In fact, analysis from the Consumer Financial Protection Bureau found that people with existing debt who took out a credit-builder loan actually saw a small decrease in their credit scores.
The money held for a credit-builder loan provides security for the lender in case of default. You’ll make fixed monthly payments on the loan, so you’ll be building savings at the same time as improving your credit score. As you make on-time payments, the lender will report them to the major credit bureaus, which will give you a positive payment history. But keep in mind that they’ll report late payments as well, which can hurt your credit score. That’s why it’s important to choose a loan with a monthly payment you can afford. Don’t borrow too much, and keep the term shorter than two years, according to NerdWallet.
Get a Certificate-Secured Loan
If you’re a member of a credit union and have money in a share certificate or savings account, you can use that reserve to secure a loan that can help you build credit. Some banks also offer CD-backed loans. With secured loans, the funds you have saved at your financial institution are frozen during repayment. You may have access to some of the money as you make monthly payments, or you may need to wait until the entire balance is paid.
Get an Auto Equity Loan
Loans secured by the equity you have in your vehicle are much easier to qualify for than unsecured personal loans. The lender will still run a credit check, but you may be eligible even with a subprime credit score. If you need access to cash and you have equity in your vehicle, an auto equity loan could be a good option. You’ll pay a higher interest rate than you would with a credit-builder loan, but you’ll have immediate access to the funds.
It’s important to keep in mind that if you default on an auto equity loan, you could face repossession. Be sure to select a loan with a monthly payment you can afford. You’ll only build credit from this type of loan if you make on-time payments, so set up automatic payments to ensure you don’t forget.
Take Out an Installment Loan
If you don’t qualify for an auto equity loan and you need access to cash, consider taking out an installment loan. You may qualify with any credit score, but you’ll need to show proof of income. Interest rates on these loans are typically high, sometimes in the triple digits, but unlike other high-interest products, installment loans can help you build credit. Many installment lenders report on-time payments to the three major credit bureaus.
Borrow Money with a Co-Signer
The least costly method of borrowing money that you can access immediately is to take out a personal loan with a creditworthy co-signer. The lender will use the co-signer’s credit score to determine your interest rate. On-time payments will show up on both your credit report and your co-signer’s credit report. Conversely, if you default, it will damage the co-signer’s credit as well as your own. Your inability to repay the loan could also destroy your relationship with the friend or family member who agreed to co-sign for you.
If you’re going to go this route, make sure the monthly payments fit into your budget, and don’t extend the term beyond two years. Check in with your co-signer monthly to let them know you’ve made the payment, and if you can’t afford it, be upfront. You should also prequalify with several lenders to find the best rate and avoid choosing a loan with prepayment penalties. If your co-signer has excellent credit, you should be able to find a low-interest personal loan from an online lender that doesn’t come with any fees.
Join a Nonprofit Lending Circle
Lending circles are groups of people that pay into a pool and take turns borrowing and repaying the funds. To join, you’ll need to show proof of income. Your debt-to-income ratio will also be evaluated, so this might not be an option if you’re drowning in debt. You may also be required to take financial education courses in order to participate.
When it’s your turn to borrow, your payments will be reported to the major credit bureaus. According to the Mission Asset Fund, an organization that offers lending circles, participants see an average jump in their credit score of 168 points. Fees and interest rates can be much lower than traditional forms of borrowing. Some lending circles are interest-free, and some borrowers use these loans to tackle high-interest debt such as payday or title loans.
Taking Advantage of Your New Credit Score
Once you’re able to build credit with a loan, you can start using rewards credit cards to earn cash back. You may also want to refinance your mortgage, auto, and student loans to take advantage of the lower interest that will be available to you with your new credit score. Refinancing replaces your current loan with a new one that has a lower interest rate or monthly payment.
You should also take steps to ensure your credit score doesn’t drop again. Look back on your financial history, and evaluate where you went wrong. Did you fail to plan a budget? Did you overspend? Do you need more income? Make the necessary changes so you can stay on track with maintaining your credit health.
How to Maintain Your Credit Health
With any lender that reports payments to the credit bureaus, you’ll build credit just by making your payments on time. Once your credit score gets a boost, you’ll want to take steps to maintain good credit health.
Apply for a Credit Card
Once you’re in the fair credit bracket with a score of 580 or above, you may qualify for a retail credit card or secured card. A score in the 600s may qualify you for an unsecured credit card, which often comes with perks like rewards or an interest-free introductory period, reports CreditCards.com. Credit cards provide convenience, help manage irregular income, and can be a lifeline in the case of an emergency. Just opening a high credit card with a high limit can improve your credit score, and making on-time payments can raise your score even further.
Just don’t apply for too many credit cards at once, since each application will require a hard credit check, which will cause a small and temporary reduction in your credit score. Choose your first credit card wisely and wait to apply for your second until your credit score recovers.
Pay Your Bills on Time
Your payment history accounts for 35 percent of your FICO score, making it the single most important factor in your credit health. Be sure to always make at least the minimum payment on your credit cards, and keep up with your student debt and other loans as well. You can even get credit for paying your Netflix and utility bills on time with Experian Boost.
Keep Your Debt Balance Low
Outstanding debt makes up 30 percent of your FICO score. To maintain healthy credit, experts generally recommend keeping a credit utilization ratio of 30 percent or less. That means that if you have a $5,000 limit across your credit cards, you should try not to carry a balance higher than $1,500, even if it means you need to make payments twice a month.
If you have a lot of outstanding debt, you may need to reevaluate your budget or apply a debt reduction strategy. One of the cheapest and fastest way to get out of debt is to use the debt avalanche method. This involves prioritizing your highest interest debts and keeping up with the minimum payments on the rest.
Final Verdict
Your best option for building credit will depend on whether you have savings or assets, how much outstanding debt you have, and whether you need to borrow cash right away. If you need to borrow money and want to build credit at the same time, consider an installment loan, auto equity loan, or lending circle. You could also take out a personal loan with a co-signer. If you don’t need to borrow and your goal is to build credit, a credit-builder loan, certificate-secured loan, or lending circle will allow you to do so at a low cost. If you’re in over your head with debt and your credit is a mess, these may not be viable options; you may need to seek assistance from a nonprofit credit counseling agency.
The information contained herein is provided for free and is to be used for educational and informational purposes only. Consult a financial professional for specific help with your situation.