A high credit score could save you money. Credit scores could impact loan terms and rates for what house you buy or rent or car you drive. In addition, typically, your credit score will affect what interest rate you get when you borrow money. A higher credit score could result in a lower interest rate, which can help you save money in the long run.
Some borrowers use secured loans to help build their credit. Increasing your credit score with one of these loans could put you in a better position when you’re ready to apply for a mortgage or auto loan. Many creditors offer secured loans. We will discuss how secured loans work and some important details to know before applying.
What Is a Secured Loan?
A secured loan is any loan that has collateral. For example, mortgages and auto loans use the home and car as collateral. It gives the lender extra assurance. A lender can seize the collateral if you stop paying the loan.
You can use cash, investments, personal belongings, and other items as collateral. Lenders may work with you even if you think you have a low credit score since secured loans have less risk. If you primarily want to take out a secured loan to help build your credit, you can use a credit builder loan. This secured loan uses money as collateral, and your payment history is reported to the major credit bureaus.
Secured Loan vs. Unsecured Loan: The Differences
Secured loans rely on collateral to help minimize the lender’s risk. This dynamic results in lower interest rates and easier access to capital for people with bad credit. Unsecured loans do not require collateral, but lenders will charge higher interest rates in exchange for greater risk. Credit card debt is a well-known example of an unsecured loan. Credit cards don’t have collateral, but they have double-digit interest rates. Creditors can sue you and get you in court if you don’t pay debt long enough.
How Does a Secured Loan Build Credit?
Many borrowers use secured loans to help strengthen their credit. Extra points on a credit score can translate into significant savings and opportunities. Secured loan borrowers follow this model to increase their credit scores.
The Lender Sets Aside Money
Creditors use loans to earn a return on their sitting capital. The lender lets you borrow money for your loan. You have to put up collateral so the lender incurs less risk. Some lenders request specific types of collateral, such as cash or investments.
You Make Monthly Payments
The lender will ask for payments based on the agreed-upon terms. These may be monthly or weekly payments. You may be able to lower your payment by asking for a lower principal or extending your loan’s term. Each payment gets you closer to paying the loan in full.
The Lender Reports Payments to Credit Bureau
The credit bureaus use various factors to determine your credit score, but payment history is the largest category. Payment history makes up 35% of your credit score, and on-time loan payments could strengthen your history. Lenders report your payments to credit bureaus to simplify the process and ensure your credit score increases with each on-time payment. Some lenders have grace periods where they delay reporting late payments. You shouldn’t rely on this benefit, but knowing the limits of a lender’s generosity before working with them is good.
The Lender Releases the Funds
Once you fully pay off the loan, the lender will release the collateral. You have outright ownership of the collateral after paying the loan. Credit builder loans use cash as collateral, but other secured loans may have different collateral requirements.
Is a Secured Loan Right for You?
Borrowers like secured loans for their lower interest rates and easier access. You don’t need the best credit to access secured loans. However, some borrowers may feel anxious about putting down collateral. They may worry about the possibility of losing an investment due to default or straining their budgets.
A secured loan is best for someone rebuilding their credit who can afford the monthly payments. If you continue paying the loan each month, you will not lose your collateral. A mortgage or auto loan provides you with a useful asset at the end of the loan, while a credit builder loan strengthens your credit score. Secured loans provide great benefits if you can stay on top of monthly payments. If you are nervous about paying off the loan, you should consider a lower loan amount or adding more years to the backend of the loan.
How Do You Get a Secured Loan to Build Credit
Some borrowers do not have high enough credit scores to apply for a mortgage or auto loan. Borrowers who just made the cut may face higher interest rates which can add over $100/mo to their budgets. You can refinance in the future when you have a higher credit score, but rising interest rates can make it challenging to save money with a refinance. A secured loan can fortify your finances; follow these steps to help if you are looking into getting a secured loan:
- Choose a Lender: Many financial institutions offer secured loans. You can reach out to banks, credit unions, and online lenders. You can compare rates and requirements to discover the best loan for you.
- Comply with Loan Requirements: Secured loans require some type of collateral. Some creditors will ask for a minimum cash deposit, while others may ask for other items as collateral. You should also have all of the necessary documents. Lenders may ask for your social security, bank statements, and other financial and legal documents. The requirements vary for each lender and loan product.
- Review Loan Terms and Details: Check each loan’s length and interest rate. These details can significantly impact how much you pay each month toward the loan. Before accepting a loan, you should consider how much you can fit into your budget.
- Submit Your Application: Ask the chosen lender for an application and fill it out. Some creditors require borrowers to pay a small application fee.
- Start Making Payments and Build Your Credit: Each on-time payment gets reported to the major credit bureaus. Payment history is the largest category that influences your credit score. A single on-time payment can improve your credit score. Combine that initial payment with a year of successful loan payments, and your credit score growth can gain momentum.
- Monitor Your Progress: Frequently check your credit to see how your loan repayments impact your score. You should also monitor other debt, as unpaid credit card debt and other obligations can undo the positive effects of on-time payments for a secured loan.