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A secured loan can help you build credit when managed responsibly, but you'll want to first make sure the loan fits your budget. Secured loans are backed by collateral, which is a valuable asset you could lose if you fall behind on payments. On top of that, missing loan payments will have a negative impact on your credit. There are other credit products that can help you build credit without as much risk.
The good news is that, if a secured loan is the right choice for you, it may be easier to get than an unsecured loan. And since a loan backed by collateral presents less financial risk to a lender, you may be offered a lower interest rate as a result.
When you choose a secured loan that you can comfortably afford, you'll get access to financing that helps you advance your goals plus the benefit of strengthened credit through on-time payments. Here's how to do it.
What Is a Secured Loan?
A secured loan is backed by collateral, an asset that acts as a guarantee against the money you borrow. Auto loans, mortgages and home equity loans are common types of secured loans. In the case of auto loans, your car is the collateral; for home equity loans and mortgages, the collateral is your home. There are also secured personal loans.
When you receive a secured loan, you'll typically make a fixed monthly payment to the lender that includes the principal and the APR you've been approved for. You'll make payments according to the loan's term. Auto loans typically have terms from 12 to 84 months, and mortgages from 10 to 30 years. When the loan is paid off, the account and your payment history will remain on your credit report.
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Can a Secured Loan Help You Build Credit?
Your credit will benefit from a secured loan if you make on-time payments. Payment history accounts for 35% of your FICO® Score☉ , making it the most significant single factor that impacts your creditworthiness. Positive payment history will remain on your credit report for 10 years after you pay off the loan.
On the flip side, negative marks associated with the account, including late payments, will stay on your credit report for seven years. Before taking out a secured loan, budget for your monthly loan payments to help you avoid damaging your credit.
There is a loan type, called a credit-builder loan, designed specifically for those interested in building or rebuilding credit, though it's not a traditional secured loan. They work like this: The lender deposits the loan balance into a savings account they control, and you'll then make fixed payments for a period of months. Make sure the lender reports your activity to the credit bureaus (Experian, TransUnion and Equifax), which could improve your credit. When the loan is satisfied, the lender will give you the total balance, which may include a portion of the interest you paid or that grew in the account. As a result, you'll save money and build credit simultaneously.
Are Secured Loans a Good Idea?
A secured loan can be a good idea if you:
- Have a true need for the loan: This means it helps you meet other financial goals and is not merely a means to build credit. (Credit-builder loans are an exception.)
- Can comfortably fit the monthly payment into your budget: Use a loan calculator to determine exactly how much your monthly payment will be, and check whether it's affordable based on your current income and expenses. Using a budget plan like the 50/30/20 rule—or at least checking your monthly payment against its guidelines—can help.
- Have an emergency fund: It's ideal to have a flush savings account you can draw on if you lose your job or other difficult circumstances arise and you need to cover loan payments on less income.
- Have experience with credit already: You may already have another loan or a credit card, and the confidence that you will make every payment on time.
How to Get a Secured Loan
The process for getting a secured loan, and the eligibility requirements you'll need to meet, vary by loan type. But in general, start the process by comparing multiple loan offers to ensure you choose the best option for you, ideally with the lowest interest rate available. You'll typically apply for the loan directly with the lender, and you may need to provide information about your income, current debt payments, housing costs and more.
You'll also undergo a credit check, and the lender may have minimum credit score requirements. You may be able to get prequalified or preapproved for certain loans, which can help you compare offers before going through the full application process.
Once you've been approved, you'll receive a disbursement of the loan and will generally start repaying right away according to the loan terms. It's best to set up an automatic transfer of your monthly bill to the lender so you never miss a payment.
Additional Ways to Build Credit
If a secured loan isn't right for you, there are other ways to build credit. Try these strategies:
- Get a secured credit card. Like a secured loan, a secured credit card requires collateral. In this case it's a cash deposit, which in turn will likely be equivalent to your credit limit. If you don't pay your bill, your card issuer will keep some or all of your deposit—and your credit score can take a hit as well. Some credit card issuers will return the deposit to you and convert you to a traditional unsecured card after you've made a number of on-time payments.
- Become an authorized user on a credit card. Ask to be added to a trusted family member or friend's credit card account as an authorized user. Typically, that person's account activity will appear on your credit report, but you won't be liable for the payments or any resulting debt. This strategy generally works best if you're new to credit.
- Apply for a loan with a cosigner. If you won't qualify for a loan on your own, you can apply with the help of a cosigner, who will be responsible for the debt if you can't pay. That person's more established credit history can help you get approved or get a lower interest rate, but it's important that they're comfortable with the loan showing up on their credit reports too.
- Get credit for on-time bill payments. Experian Boost®ø is a free feature that can help you increase your FICO® Score based on your Experian credit report. It adds your record of making utility, phone, rent and some streaming service payments to your credit history, which can help you build a credit score if you don't have much experience with credit or are looking to improve your score.
The Bottom Line
A secured loan can help you build credit when you make every monthly payment on time. But since getting a secured loan is a big commitment, ensure that you truly need the loan and that it serves a purpose beyond helping you build credit. Otherwise, there are several additional options for growing your credit, such as credit-builder loans and secured credit cards, that won't have such a large potential impact on your budget.