A secured loan can help you rebuild your credit score or establish a credit rating if you’ve never had credit before. A lender will give you a loan if you provide some security, or collateral that the lender can sell if you fail to pay off the loan.
Even if you have a low credit score, you can still get a secured loan. By taking a security interest in assets you own, like bank accounts; certificates of deposit (CDs); real estate; and smaller personal items with value, the bank is lowering its risk of lending to you. If you fail to repay the loan, the lender can take the property you have pledged as payment-in-full for the amount you owe.
Secured loans help you rebuild credit if you make the payments on time and in the proper amount. Secured credit cards also serve the same purpose because the lender or credit card issuer reports your on-time payments to the credit bureaus.
Making more than the minimum payment improves your credit score faster. However, it is good to take about 12 months to repay the loan so that you have a positive payment history appearing on your credit record over a period of time.
Using Your Assets To Guarantee A Secured Loan
Using a bank account or CD as security for a loan is a good idea when you want to build credit. You can also use other assets like heirlooms and antiques, real estate, your car or other personal property. However, if you are taking the loan intending to rebuild your credit—and not necessarily because you need the money, using a savings account or CD is an effective way to do it.
What you will need to do is open an account with a bank or credit union. Then, ask the bank to give you a loan, secured by the funds in the savings or CD account. Understand that in exchange for the loan, you will not have access to the funds in the account because the bank has now locked them as security until you pay the loan in full.
The drawback is that your newly-opened bank account or CD will pay you less in interest than what you will be paying on the secured loan. You will, in effect, be paying out slightly more in interest on a secured loan, than you will be earning in interest on the money you’ve put up to get the loan. However, you are on your way towards building your credit.
The two most important things you can do going forward to build your credit score up are to make your payments on time and pay more than the minimum amount due. You’ll want to make sure that the bank or lender will report your loan payments to the credit reporting agencies.
If the lender does not report to the credit bureaus, then you should choose a different lender. Remember, your reason for wanting a loan is to demonstrate a responsible credit history on paper and rebuild your credit.
What is the Minimum Asset Value You Can Pledge?
The amount of security a lender requires for a personal loan can vary from as low as $50 to upwards of $3,000. Search for a bank that requires a minimum amount that works with your budget and is in line with what you can afford. If you are asking for a loan secured by real estate, the lender may give you a loan equal to a certain percent of the value of your equity in the property.
Secured Loan Interest Rate
Because you have no credit score or a low credit score, a lender would typically charge you a higher interest rate for an unsecured loan than it would charge to people with good credit scores. But, by offering security for the loan, you will get an interest rate lower than the rates lenders charge for an unsecured loan.
Keep in mind that the reason you are doing this is to repair your credit score, not because you need the funds from the secured loan. In fact, you should consider not spending the funds from the loan. Instead, bank the money and make the payments right back when they are due and in full over a 12-month period.
How Much Can You Borrow?
On most secured loans, the lender will usually allow you to borrow around 80-95% of the value of the collateral you’ve put up.
Secured Loan Repayment Terms
The length of time you have to repay the loan (the term) varies among lenders. A credit union or bank commonly writes loans for one-to-five years.
Interest-only loans, more common a decade ago, require only that you pay the interest due each month. This means that you are paying nothing toward the principal balance during the loan term but will have to come up with the full amount at the end of the term.
Secured Loans Are Good Credit-Building Tools
Ideally, you should try to pay off the secured loan over a 12-month period so that the lender can report your on-time and full-payments to the credit bureaus. Your steady payments are what will help you rebuild your credit score. Missing a payment or failing to pay the minimum amount due each month will severely hurt your credit score and derail your efforts at rebuilding your credit.
Also, you don’t want to lose the funds in the account or lose your property because you missed payments, especially if you have almost paid off the loan. If you are stretched for funds, simply start with a smaller, secured loan of $300-500 and secure it with property that you can part with if you fail to pay in full.