by Jen Smith & Honorine Uwishema
Credit unions and banks have many loan options to help you build credit. When you take out a loan and are able to show a good repayment history, you will begin to build credit because your payments are recorded by the credit reporting agencies. It is important to always pay on time, to only take out a loan you can afford, and to stay in communication with the credit union or bank if you are having trouble making payments. If you want to build good credit, you are probably wondering where to start.
Unsecured or Secured?
When you borrow money, there are two types of loans: secured and unsecured. With an unsecured loan, you don’t need any collateral (a physical item you pledge as security) and you get the funds right away to use on whatever you like. Some unsecured loan types are a personal loan, a line of credit, or a credit card. These are usually loans for smaller amounts, which are ideal for building credit with demonstrated on time payments. Interest rates are typically higher than for secured loans.
With secured loans, you do need to pledge an item as collateral. The item you are purchasing usually qualifies as the collateral, such as a car or boat. You can also secure a loan with money in your savings account. Because there is an item of value that can be collected upon if the loan is not repaid, the interest rate is lower and secured loans may be easier to obtain.
Personal loans are typically used for a one-time purchase. They build your credit as you pay it back. The interest rate is usually fixed, and payments are the same every month until the loan is repaid. Each on-time payment creates a record in your credit history and, over time, these monthly records help generate a credit score. You can use the funds however you like, such as for a vacation, security deposit on an apartment, or even catching up on bills.
With a line of credit, you are approved up to a certain dollar amount, but do not need to use it all at once. Your payments and the amount of interest you pay are determined by the amount you owe at any given time. This is a revolving account, which means that once you pay the money back, it is available again for you to use, as long as the account is in good standing. Each monthly payment is recorded in your credit history. It is important to not always use the full amount available, as that may adversely impact your credit. When you want to use funds from the line of credit, you can transfer the money into your checking account and use your debit card, write a check, or withdraw cash at your credit union or bank.
A credit card is very similar to a line of credit, but gives you a card for purchases. When you have very little credit or no score at all, you may need to put down a security deposit to be approved. This becomes a “secured credit card.” With a good repayment history, the financial institution may give you back your deposit (upon request) and upgrade you to an unsecured credit card with better terms such as a lower interest rate and a higher credit limit.