Have you ever felt like building your credit score is an impossible task beyond your control? If so, you might want to change how you think about credit scores. After all, your credit score simply reflects what is found on your credit report and shows you how you manage debts.
You can’t change what has already been done to tarnish your credit score, but there are things you can do to improve it. One way to improve your FICO score is to take out an installment loan, but you may wonder how installment loans affect credit scores? In this blog, we’ve covered everything you need to know about installment loans and how to use them to your advantage when building credit.
What Are Installment Loans?
An installment loan is a long-term loan type that differs from a short-term, title, or payday loan in that lenders design it so that borrowers can pay it off in simple and easily manageable equal installments over a specified period of time until the loan is paid off.
Each installment includes the interest rate on the loan and the repayment of a portion of the principal amount you borrowed. Usually, your loan repayment is due monthly and remains the same throughout your loan term, making it easy to budget in advance for repayments.
There are many different types of installment loans, including personal loans, car loans, student loans, bad credit loans, and mortgage loans. It’s important to note that installment loans are not the same as revolving credit accounts, even though both give you access to needed funds. A revolving account involves revolving credit like credit cards with varying monthly repayments and no predetermined end date.
Should You Get an Installment Loan Just to Build Credit?
Taking out an installment loan solely to build your credit is usually unwise since it can lead to bad credit or worsen your credit score. However, there is an exception to this rule – credit-builder loans. A credit-builder loan is a unique type of installment loan offered by companies like Primo Personal Loans to help individuals build their credit profile if they have no credit or thin credit.
Unlike other installment loan types, a credit-builder loan is deposited into a savings account. So, if you have been approved for this type of loan, you’ll receive notice that the money has been put into a savings account that you cannot access until after you’ve paid off the loan.
Paying the monthly installments on time will build your credit history. Once you’ve paid off the loan, you’ll have access to the savings money. You can use this money as an emergency fund or put it toward a personal loan, or auto loan, to continue building your credit.
However, failing to pay on time will hurt your credit score, and borrowing too much could strain your budget unnecessarily, leading to missed monthly payments. In addition, you should note that a credit-builder loan is often an amortizing loan. This means that the loan is structured so that each installment covers the interest and a portion of the principal. The interest will be paid off first each month, and then the remainder will be used to reduce the initial amount you borrowed.
How Do Installment Loans Affect Credit Scores?
An installment loan can affect your credit score in several ways. Below, we’ve detailed the advantageous and disadvantageous ways an installment loan can lead to a good credit score or a bad credit score.
How an Installment Credit Loan Can Build Your Credit Score
- It establishes a payment history: Did you know that an estimated 35% of your FICO score is your payment record? Establishing a payment history is one of the most valuable ways an installment loan can help build your credit score. If you consistently make monthly payments on your installment loan, you’re developing a positive history as a reliable payer, which shows on your credit report. If you want to instill a failsafe in your installment loan so that it is paid on time to reduce the likelihood of any missed payments, it is worth considering signing up for autopay.
- It decreases overall credit utilization: When your credit score is calculated, your total available revolving credit is compared to the amount of revolving credit you’re using. This credit utilization ratio accounts for 30% of your overall score. Taking out an installment loan to pay off revolving debt can improve your credit utilization ratio and thus boost your credit score. This is because your installment loan will remove the revolving account balance and add it to your installment account. The most common type of installment loans used specifically for this purpose are debt consolidation loans. An added benefit of a debt consolidation loan is that you’ll make your debt more manageable by streamlining the repayment process.
- It diversifies your credit mix: If you take out an installment account, you can diversify the credit mix of accounts in your name and boost your score. For example, since your credit mix accounts for 10% of your credit score, holding various credit accounts like an auto loan, credit card, and an installment account increases your chances of good credit. In addition, lenders get a reliable indication of how you manage different lines of credit and loans based on your credit mix. It gives them a better idea of how risky it would be to lend to you, which is why paying on time is vital.
How an Installment Loan Can Harm Your Credit Score
- Missed loan repayments: On-time payments boost your credit score, but the fastest way to lower your it is to miss payments. Unfortunately, even one missed payment can have a detrimental impact on your growing credit score. It’s best for individuals to at the least make their minimum payment on loan payments and other forms of credit wherever possible.
- An excess of debt: Taking on new debt adds to your total debt load, which, in turn, can lower your credit score. If you have too much debt, it instantly affects the ‘amounts owed’ portion of your credit score, which, as you now know, makes up 30% of your FICO score. Adding an installment loan to your available credit if you already have student loans, credit card debt, and an auto loan, for example, can strain your budget and negatively increase your debt-to-income ratio (DTI). Lenders will also be less likely to offer credit or an installment loan if your DTI is too great.
- Hard inquiry: It is important to be aware that applying for any type of loan can cause your credit score to dip marginally because loans are hard inquiries on your credit. So, if you apply for too many loans at too many places, hoping to increase your chances of approval, you risk dropping your credit score by ten points for each hard inquiry.
Additional Ways to Help Your Credit
Besides securing an installment loan, there are ways for you to help your credit. Below, we’ve briefly touched on a few other options available that you should consider:
- Pay off credit card balances: To ensure your credit score remains steady and continues to grow healthily, you must avoid using more than 30% of your credit limit every month and pay off your credit card balances monthly. By limiting the amount of credit card debt you incur, your score will reflect that you can pay debts responsibly. This has numerous positive effects on your personal finances. For example, if you can demonstrate that your payments are always paid on time and that you don’t use all your available credit, you’re more likely to receive future loan offers with lower interest rates instead of high-interest rates.
- Evaluate your Experian credit report: Few people realize that Experian offers consumers a yearly free credit report. Since Experian gives you access to your payment history, you can use this report to evaluate your current credit score and identify areas for improvement.
- Consider using Experian Boost: Another way to improve your credit is to give the various credit bureaus access to your payment history for accounts you pay that might not be included in your credit report. For example, if you pay for streaming services, club memberships, and subscription boxes from a different bank account, you can ask for these to be included in your report to show that you make consistent, on-time payments. Experian Boost is useful in that it gives individuals access to their credit reports and allows them to add these types of accounts. It’s a free service, so consider using it to improve your FICO Score on your credit file.
Frequently Asked Questions
Here are some of the most frequently asked questions about installment loans:
Unlike other loan types, installment loans are closed-end debt, meaning you will be responsible for paying the loan amount off over a predetermined and agreed-upon period of time, also known as your loan term.
For example, an auto loan is a type of installment loan that might have a five-year term and a minimum monthly repayment of $500. Under this loan term, you would need to pay the $500 monthly for five years until the loan balance has been paid off.
Installment loans differ from lines of credit or credit cards in that these options offer revolving types of credit, whereas installment loans are close-ended. You cannot reuse the installment credit you pay toward the loan balance.
There are many ways to pay off an installment loan. For example, you can make biweekly payments instead of monthly payments, which will help you pay off the loan term faster. You can also pay off an installment loan quicker by rounding up monthly payments, making an extra payment yearly, or refinancing another loan.
There is no limit to how many installment loans you can have at any given time. You can take out multiple if you qualify for multiple installment loans based on your credit score, debt-to-income ratio, and the income that a lender requires. However, this is not advisable since it can negatively impact your score later down the line.
Many different financial institutions and lenders offer installment loans, like banks (which offer the lowest interest rates), online lenders, and credit unions. One of the best is Loan For Any Purpose.
The primary difference between installment loans and revolving credit is that you can borrow a lump sum of money from an installment loan lender and pay the money back in monthly installments. In contrast, revolving credit gives you access to continuous lines of credit that you can borrow from as needed.
Summary
Now you know more about installment loans, whether you should secure one for the sole purpose of building your credit score, and how they can affect your credit score. If you’re interested in an installment loan to improve your credit, you can fill in the online inquiry form. Our lenders offer a simple, which allows them to offer installment loans for bad credit or good credit. Reach out to them today!
