If you’re looking for ways to build your credit, installment loans are likely on your radar. However, before you take out a loan, it’s important to understand what installment loans are and how they can help (or hurt) your credit score.
Key takeaways:
An installment loan is a debt that provides you with a fixed lump sum of money that you repay in regular installments over a set time period. Installment loans differ from revolving credit, such as credit cards, in that you can’t continuously use the credit. Instead, you’ll need to apply for a new loan if you need to borrow additional money.
Here are some examples of installment credit:
Taking out an installment loan will impact your credit. However, whether that impact is beneficial to your score depends on how you manage the loan. Here are a few ways that installment loans can help you build credit.
Taking out an installment loan is one way to develop your payment history, which accounts for 35 percent of your FICO® credit score. For this to positively impact your credit score, you’ll need to ensure that you’re making regular, on-time payments. Even just one late payment on an installment loan can have a significant negative impact on your score.
To ensure you make your payments on-time, consider signing up for autopay so you don’t miss due dates.
Credit mix refers to the different types of credit accounts you have, and it makes up 10 percent of your credit score. Having various credit accounts showcases to lenders that you can handle managing different types of credit. A history of successfully managing a mix of both revolving and installment loans signals to lenders that you’re a low-risk borrower.
If you have previously only taken out revolving loans, an installment loan can add variety to your credit mix. However, credit mix only accounts for 10 percent of your credit score, while payment history accounts for 35 percent. Therefore, you should only take out new loans if you feel confident that you can make on-time payments.
Additionally, you should avoid taking out too many loans in a short period, since multiple hard inquiries on your credit report can lower your credit score.
Another factor that makes up a large percentage of your credit score is your credit utilization, or amounts owed. Accounting for 30 percent of your credit score, credit utilization is the percentage of revolving credit you’re using compared to your overall credit limit.
Taking out an installment loan to pay off revolving credit, such as your credit card bill, can help lower your credit utilization by reducing the balance on your credit cards. Referred to as debt consolidation, this involves combining your balances of revolving credit lines into an installment loan. As a result, you’ll only be making one payment monthly instead of multiple payments.
While installment loans can help your credit, taking out an installment loan solely for credit-building purposes is not recommended. In fact, an installment loan can have the opposite effect if not managed properly.
Here are some scenarios in which taking out an installment loan can hurt your credit:
You should only take out an installment loan if you need the money to make a specific purchase and can afford to make payments on time.
If you’ve decided that an installment loan isn’t the right option for you, consider these other ways to build credit:
While taking out an installment loan can help you build credit, if you don’t need the loan, consider exploring other options. There are less-risky ways to establish a credit history and improve your score.
However, before you start taking steps to help your credit, knowing where you’re at is important. Lexington Law Firm offers a free credit assessment, which includes your credit score, credit report summary and a credit repair recommendation. Try it for free today.
Note: The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.
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