How to Build Credit Using Your Money as Collateral
Have Money but Need to Build Credit?
If you lack credit or need to rebuild it, you can use your own money as collateral for a loan rather than relying on your credit score. Even if you don’t need a loan for the actual money right now, you should focus on building or repairing your credit as soon as possible.
Think about it for a moment–you wouldn’t wait (or shouldn’t) until the night before a big event to lose 20 pounds, would you? No, you would start working on your nutrition and fitness months ahead of time.
The same is true for your credit—think of it as a muscle. You have to work on it and build it, which takes time.
One way to strengthen your credit is by using your money as security/collateral for a loan, even if you don’t actually need a loan.
Why? Because it will help you build credit.
Your payment history is a huge factor, so making payments on the loan each month will help you. And even though it’s your own money you’re paying back, it’s still crucial to make your payments on time.
Your Credit Score is Important For More Than Loan Rates
Why does your credit score matter if you don’t need a loan for a large purchase?
You can be financially strong with your savings and still face difficulties obtaining needs due to your credit score. Lack of money isn’t always the issue—sometimes, it’s lack of credit that’s giving you problems.
Having bad or no credit can hinder you in many other areas, such as:
Getting a decent rate on a loan
Being approved for an apartment/condo
Getting hired at a new job
Cell phone contracts
Car insurance rates
Qualifying for utilities without a security deposit
We all know that paying your bills on time is key. However, there are other ways you can help increase/build your credit by using your own money.
Use Your Money as Collateral With a Secured Loan
What is a secured loan, and how do they work? Secured loans may seem unfamiliar to you because they’re not exactly the same as traditional loans. In this post, the secured loans discussed involve borrowing against your own money rather than asking for a loan to buy something or pay off debt.
If you have some money saved up (you don’t need a lot), then make your money work for you!
Remember in this post that we assume it isn’t money you lack— but credit.
You’ll find that most local credit unions and banks offer these secured loan options. The loans are reported to the credit bureaus, which helps to establish and build up your credit score.
Share/Savings Secured Loan
Credit unions call savings accounts “Share Accounts” because that is your share in the credit union. Credit union members are owners of the credit union, and they each have a “share” in it.
You’ll deposit money in a savings account, which will then be “frozen,” meaning you won’t be able to access the funds. Each month, you’ll pay a fixed amount to the lender. As you pay down the balance with some financial institutions, you will see funds “unfrozen” each month in your savings account.
Don’t worry–the money in your savings account still earns interest even though it’s frozen. When you finish paying off the loan, the total amount of your frozen money is completely thawed out and is all yours again.
CD Secured Loan
With a CD loan, you use your certificate of deposit as collateral. The credit union/bank keeps the CD until you fully repay the loan.
You’ll make monthly payments just as you would with an unsecured personal loan. Because your CD is still held at the institution, you continue earning interest each month on your certificate.
This type of loan usually has a lower interest rate than an unsecured loan—and some institutions have a set rate(such as 2% higher than the rate of your CD) versus basing it on your credit score.
That is ideal for someone who may have a low credit score, where they can be looking at double-digit interest rates on unsecured loans—if approved at all.
Ouch!
It can also be easier to get approved for a CD loan than a personal loan because you are providing cash as the collateral, making the loan low risk for the lender. If you miss your payments, the lender can take the money from the CD to bring it current/pay it off.
Secured Card
A secured credit card requires a security deposit (your money) that is “frozen” in a special savings account used as collateral to serve as your credit limit. You use your secured card just like you would any regular credit card. The difference is that your limit is based on the amount of money you provided as the security deposit.
So, if you want a credit card with a $500 limit, you would first need to deposit at least $500 of your own money (sometimes a bit more than the limit is required to be deposited) in a special savings account.
The credit union/bank will link that savings account to your secured card, so you technically spend your own money each time you use your card.
You make a monthly payment the same way you would for a standard credit card. Payment history is part of what builds up your credit, so you need to use the card to have payments to make.
As your credit score improves, you may qualify to convert the secured card to a standard credit card. You would then receive the money back that you had “frozen” for your card use.
It’s a win-win!
Before going with just any secured card provider – review their interest rates. Some card companies will charge double-digit rates hovering at 20%-24%. That’s high! Check with your local credit union or bank first. Also, avoid paying an annual fee for having a secured card.
It can’t be stressed enough to check with a credit union near you – they offer more than you probably thought and not all of them are restricted to specific employee groups.
Start Building Your Credit With Your Own Money
For the lowest rates, seek out a local credit union for your secured loan. Most (unless they’re very small) offer the same products and services as larger banks but with better rates on deposits and loans.
Call your credit union first to see if they base a secured loan on your credit; some may still do so, and you could be declined if your credit is poor.
Don’t get declined for services or incur higher fees and rates because your credit score isn’t strong enough. Try out one of the above loans to build your credit and make your money work for you.
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Attention-Your credit score impacts more than just a loan rate