Credit is a necessary component of every consumer’s financial life, for better or worse. Without a strong credit history and score, it is an uphill battle getting approved for a new credit card, auto loan, or mortgage for a home.
It can also be difficult to secure a new job or apartment, as companies and landlords take bad or no credit as a warning sign. While most adults are aware of the importance of credit, there is quite a bit of conflicting information about what helps boost one’s credit profile and score – and what brings it down.
Loans of all shapes and sizes can be used to improve one’s credit over time, but only when they are managed well and paid on time and in full. However, borrowers need to understand that different types of loans may impact their credit history and score in varied ways.
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Here’s a quick guide to several loans consumers can use and how those play a role in personal credit improvement.
Loan Types and Their Impact on Credit
#1. Secured Loans
Any loan that is backed by some type of asset is considered a secured loan. However, most lenders market secured loans as those tied to a borrower’s savings account.
The amount available to be financed with a secured loan equals the amount available in one’s savings account. This type of loan offers the lowest interest rate because the risk to the lender is so low, and it is a good option for borrowers with lackluster credit.
Secured loans are reported to the three major credit bureaus just like unsecured loans, which means so long as payments are made on time and in full, secured loans have a positive impact on credit.
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#2. Unsecured Loans
Unsecured loans are not tied to any sort of collateral, and so may have a higher interest rate due to the level of risk involved. Because lenders are simply basing qualification for an unsecured loan on a borrower’s credit history, it takes a quality score and track record to qualify.
Unsecured loans are also reported to the credit bureaus, making them a positive for an individual’s credit.
#3. Title Loans
Vehicle title loans are available to borrowers who have a car, truck, or SUV they own outright. This means no other lender has rights to the car or its title.
Borrowers who are in need of quick access to financing or who have less than strong credit are great candidates for car title loans. However, car title loans are not reported to the credit reporting agencies as far as monthly payment history is concerned.
If a borrower defaults on a car title loan and it ends up in the hands of a collection agency, a title loan could have an adverse effect on one’s credit score.
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#4. Auto Loans
Taking out a loan to purchase a vehicle is based on the borrower’s ability to pay as well as their financial track record with other creditors. So long as credit is strong, an auto loan is an affordable way to buy a new or used car, and this type of loan is reported to the credit bureaus like most other loans.
When a borrower fails to make adequate payments on an auto loan, the lender may report the default which will negatively impact one’s credit score and report.
#5. Home Loans
Securing a mortgage for the purchase of a new home or refinance of a current property requires excellent credit in most cases. For example, when you apply for cash-out refinancing you’re required to have at least 620 credit score to qualify. Mortgage payments are reported to the credit bureaus like most other loans which improves credit over time.
However, missing a mortgage payment or having a home foreclosed on by the lender has a greater negative impact on one’s credit than any other type of loan.
In addition to these common loan types, there are also loans consumers can take against retirement plans, like a 401(k), through their employer. While retirement plan loans do not negatively or positively impact credit, they can have a significant impact on one’s overall financial well-being and tax circumstances.
Before using one of the mentioned loan types as a method to boost credit, take the time to understand what is required to qualify for the loan, how much it will cost, and the ramifications if the loan goes unpaid.