One of the easiest ways to build your credit is to obtain a shared secured loan from your local bank or credit union. The loan is secured by your savings account, share certificate account or money market account.
A share certificate account is similar to a certificate of deposit (CD), but it is issued by a credit union, rather than a bank. The money in your account is used as collateral to protect the lender in case you fail to repay the loan.
Shared secured loans are a way to borrow small amounts of money in the short term and help you build your credit history. Establishing good credit is important to achieving many financial goals, whether you’re buying car or a house, or simply opening a credit card.
Shared secured loans: An overview
A secured line of credit uses assets, such as your house, as collateral for a loan. A shared secured loan is one that uses the assets in a share account, otherwise known as a savings account, to back up the loan. Both banks and credit unions offer loans backed by savings. When you take out a shared secured loan, the equivalent assets within your savings account are frozen and become available again as you pay off the loan.
Shared secured loans are easy to qualify for—even for those with poor credit. Because they offer little risk to lenders, these loans typically come with low fixed interest rates, often 1% to 3% over the dividend or interest rate paid to the account by the bank. Note: The interest rate you are paid on your savings can help offset the cost of the loan.
Banks may allow you to borrow the full amount in your savings account or a percentage over a relatively short term—often 10 years or less. The maximum you are allowed to borrow varies from bank to bank. If building credit is your goal, consider taking out a small loan, which is easier to pay off quickly.
As with any loan, avoid making late payments or defaulting on the loan. If you do, your bank may impose penalties or late fees and can seize the assets in your bank account. Late payments and defaults can also hurt your credit history.
Why use a shared secured loan
There are a number of reasons to use a shared secured loan rather than simply using the cash in your savings account:
- Builds credit. If you have bad credit or no credit at all, these loans can help you build credit. Every time you make loan payments or pay off a loan, it should be reported to the credit reporting agencies, and your credit score should receive a boost. Ask your lender to report loan payments to the credit bureaus, and verify that they did so by checking your credit report. Each year, you can ask for a free credit report from each of the major credit reporting bureaus, including TransUnion, Equifax and Experian.
- Saves on future loans. While a shared secured loan may cost you some money in interest payments now, a higher credit score should allow you to save money through lower interest rates on loans in the future.
- Shared secured loans can be used for any purpose. However, it likely makes the most sense to use them to pay for something you really need, such as an unexpected car repair or home improvements that will increase the value of your home.
- Protects savings. If you have a hard time staying disciplined when building your savings, a shared secured loan may be right for you. The loan incentivizes you to rebuild your savings through loan payments, so at the end of the loan’s term you will have cash reserves that you can fall back on should you need them again.
Use Bankrate’s loan calculator to help you figure out how much your monthly payments will be.