Finding The Right Loans

How To Responsibly Use Loans When Building Your Credit

19 March 2020

April George

While you're building your credit, loans can be difficult to be approved for, and this can influence how much you're able to have a positive impact on your overall score. When it comes time to start using loans, there are several ways to use them to your advantage by doing some research, using the right kinds of loans, and looking out for options that could actually harm your score in the long run.

Explore Your Loan Options

When looking for a loan, you have many options to choose from even if your credit isn't very high. The first step is to research where you can get a loan from. While you can apply for a loan at most banks, you may be able to find better options at a credit union or a Community Development Financial Institution, or CDFI, if you're worried about interest rates. Try to avoid payday loans; not only are the interest rates around 400% on average, but they also don't affect your credit score. 

Next, while it's not always a good idea to use a loan specifically for the purpose of building credit, but if you have this in mind, there are loans specifically designed for this purpose called credit builder loans. Like a secured credit card, there are restrictions. In this case, credit builder loans keep the amount of the loan locked away while it's paid off. Once you've finished paying it off, you get the total amount of the loan. If you're solely focused on building credit, this can be a good option for you.

Apply for the Right Loans

One of the factors that influence your credit score is varying types of credit. For example, if you use credit cards, personal loans, and auto loans, this will look better on your record than someone who only uses credit cards. For this reason, it helps to use the right kind of loan in any situation you're in rather than using a personal loan regardless of circumstances. In some cases, an individual loan's interest rate may be lower than an alternative, but overall, the variety will raise your credit score more.

Still, variety for the sake of variety won't necessarily help; look for the type of loan that best fits your situation. For example, if you're looking at purchasing a new car, your best bet is an auto loan. Don't forget you can shop around for auto loans just like you can personal loans, so you don't necessarily need to get financing from the dealer you're purchasing from. If you can find an auto loan with comparable or slightly higher interest rates to a personal loan, that's the best option for you for working toward your score.

Know What to Avoid

Part of playing it safe when it comes to taking out loans is knowing which ones to say no to. The easy decisive factors are things like very high-interest rates, but there are other things to avoid and other ways to stay cautious.

First, while secured loans will often have lower interest rates and be more accessible to you depending on your credit score, this is because you're putting up something you own as collateral. For example, if you use your car as collateral, you're agreeing that if for any reason you can't finish paying off the loan, the bank can take your car to use its value against the loan's remaining balance. If you are secure financially and will have no trouble paying it off, then it could be a viable option, but if you have any doubts, either avoid the risk or talk to a financial planner.

Next, loans for debt consolidation can provide immediate relief to overwhelming debt. A consolidation loan lets you pay off the balance of several different loans, such as high-interest credit cards, and wrap it all into a single personal loan. The potential downside of this option is that it frees up your credit cards to be used again. This is another step that benefits from the help of a financial planner so you can work your way out of debt rather than simply increase it.

Finally, cosigning on a loan means having your name on a loan you may not otherwise be able to get on your own, which can be a quick way toward boosting your credit, but this comes with its own risks. Cosigning a loan means you are promising the bank you are financially able to take responsibility for the loan in the event the signer cannot, so if you aren't actually able to do this, cosigning can be a very risky move. Because there are so many other ways to safely build credit, it's best to take advantage of those instead.

For more information on loans, reach out to a provider in your area. 

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