If you search the web for ways to improve your credit score, you will find yourself overwhelmed by all the different credit card and loan options you can choose from.
Between loans for debt consolidation, secured credit cards, and installment loans, it seems like you’d need a degree in financing just to figure all these things out.
This doesn’t come as a surprise considering almost 6 in 10 of working adults in America have less than $500 in their emergency savings accounts. Is there a way to improve your personal finances? Can you use installment loans to build credit?
This guide will explain how installment loans work and what type of impact they can have on your credit score. Read along and we’ll tell you everything you need to know.
How Installment Loans Work
With an installment loan, you are borrowing a lump sum of money from a lender. This isn’t a revolving credit line like a credit card that can be used indefinitely as long as the minimum payments are made and you don’t go over your balance.
Let’s say, for instance, you need to borrow $10,000 to repair your roof. The term (length of the loan) you agreed to is for 6 years.
You are now responsible for that $10,000 plus interest. The lender will look at things like your credit score and salary to determine the percentage you’ll pay in interest.
When these factors are calculated, you will be given a fixed dollar amount that you’ll have to pay each month.
How Do You Qualify?
As you may know, when you apply for loans much of your finances will be scrutinized. Installment loans aren’t very different in this aspect. To determine whether you can pay the loan back, a lender can potentially look at your:
- Debt-to-income ratio
- Annual income
- Credit score
- Employment history
Before contacting a lender, you should always do your research first. What factors do they base approvals off of? Does the lender have a good reputation and customer reviews?
Asking yourself these questions will help put you in the right state of mind for knowing what you want from a loan. More importantly, you will know how to prepare to increase your chances of approval.
Increase your chances of approval by planning for your loan ahead of time. Start keeping a close eye on your credit score a few months before you apply.
If there are errors, help yourself by disputing them. On your credit report, you will also see if you have open accounts that are carrying high balances.
Paying those balances down will decrease your credit card utilization, which can increase your score. It will also bring your debt-to-income-ratio down. The lower that number is, the more money lenders will trust you with.
Where to Obtain an Installment Loan
You can find lenders that solely operate online. Your local bank or credit union may also have options for you. If you already do business with a particular bank or credit union, it’s possible that you’ll receive a discount or a lowered interest rate.
You should always shop around and see what multiple lenders have to offer. Read all the fine print and ask questions if something doesn’t seem very clear.
Penalties for defaulting or even paying the loan off early can occur. Some lenders charge extra fees for certain types of payments too. So, make sure you know all the ends and outs of what you’re signing up for.
Types of Installment Loans
Because there are so many different types of loans out there, things can easily become tricky. You might think the type of loan you need is an installment loan, but maybe you’ve confused it with something else like a payday loan.
Here are some common types of installment loans you’ll come across during your search:
- Student loans
- Auto loans
- Personal loans
- Home equity loans
A general rule of thumb is that installment loans cannot be reused after it’s been paid off.
Do Installment Loans Hurt or Help Your Credit?
Applying for and then receiving a new line of credit will bring your score down a bit. This is true for most lines of credit, whether or not they are installment loans.
The decrease usually isn’t a very large amount. It’s an indicator that you now have less disposable income for borrowing since you’ve just committed to a new loan. However, after making your payments on time for 3 to 4 months, you should see your credit score go back up.
With that said, the credit bureaus don’t judge all lines of credit equally. This is a fact you definitely want to be mindful of, especially if your reason for seeking to credit is to elevate your score.
High-Risk Loans Vs. Low-Risk Loans
There are two types of installment loans. Ones that are seen to have higher risks of default. And ones that are low risk.
Student loans fall into the high-risk category of installment loans. The reason is, they are one of the most common loans borrowers default on. Student loans aren’t backed by collateral, so there isn’t a treat of the borrower losing something they don’t want to lose if these loans become past due.
A type of loan that is safe or low risk is a mortgage. In many cases, something like bonds, stocks, or cars are used as collateral.
These forms of collateral secure the loan. Because if the borrower defaults, the lender will take those things and the property the mortgage was used for as well.
What Happens with Your Credit?
As a whole, installment loans don’t have a huge impact on your credit. This is especially true for loans, like mortgages, that are secured by collateral.
Loans that aren’t secured in this way do however have a bigger impact on your credit score. Although many cases are unique, the impact usually isn’t huge.
So, Should You Use Installment Loans to Build Credit?
If you have poor credit, an installment loan won’t be the best option to help you raise your credit score. Judging your credit is a major part of the lenders’ approval processes for this kind of loan.
But don’t feel discouraged, there are loan options to help borrowers with lower credit scores raise their numbers. If you want to use an installment loan to improve your score, you should have good credit with a goal of graduating to excellent credit.
There are ways you can use your installment to help your credit.
Pay on Time
If you make your payments on time every month, your credit score will improve. Missing even one single payment can bring it down several points.
Having a loan become extremely delinquent can result in repossessed property, closed accounts, or it being outsourced to a collections agency. These things will have a drastic impact on your credit score.
Work on Your Credit Mix
Having a diverse mix of credit cards and loans that are in good standing can help your credit score in the long run. The reason is lenders like to work with borrowers who can handle different types of credit accounts.
This shows that you’re responsible and it also establishes excellent payment history. Having experience with multiple types of credit also makes you less risky to do business with.
You will notice that when you make timely payments for a long period of time, your credit score will improve as your credit age increases as well.
Monitor Your Credit
Of course, your credit score is important, but it isn’t the only important line on your credit report. While you’re working on building better credit, you should also be looking at the individual elements that go into tallying up your score.
These elements include your credit age, public records (judgments and bankruptcies), utilization ratios, payment history, and inquiries. There is no quick fix to improving your credit.
It’s a process that takes time.
How to Meet Your Financial Goals
Depending on your personal credit situation, you may or may not be able to use installment loans to build credit. However, we have resources to help you take the correct steps in repairing your credit score.
So, if those are the kinds of tools and resources you’re looking for, our learning center has you covered.
If you have questions, check out our FAQ page or send us a message. We’d love to help you reach your financial goals.