How long should you keep a loan to build credit?

How to find out whether that loan is helping or hurting your credit score.

A few years ago I tried to get a loan for a new car and I was denied. The reason? I had just graduated college and had absolutely no credit. But there are solutions.

The main concern for lenders when someone has no credit is that they have little information to predict whether the borrower will pay back on time or not, as the lender has no visibility into the borrower’s financial behavior. In many cases, no credit is compared to having bad credit, even though, as NerdWallet explains on their website, “it is easier to bounce back when your credit history is nonexistent than in situations when your credit is bad,” (usually under 650 points according to credit bureaus Equifax, Experian and TransUnion).

So what do most people do when they have no credit? A good first step is taking out a loan to start building it.

Taking out a secured or credit-builder loan to build credit

By taking out a loan to build credit you are diversifying the types of credit on your credit report, in order to prove that you can consistently make payments on time.

Taking out a loan to build credit can be easy because:

• They do not require cash upfront
• You don’t need to have a good credit score to get it … because you don’t have credit yet!
• You only need proof of income

Experian, one of the three main credit bureaus companies in the United States, says, “Some (banks) offer credit-builder loans, or passbook/CD loans — low-risk loans designed specifically to help you build credit. They work much the same way a secured credit card works; for a credit-builder loan, you deposit a certain amount into an interest-bearing bank account and then borrow against that amount. The deposit is your collateral, and you’ll pay interest at a higher rate than your deposit earns it. For passbook or CD loans, some banks allow you to use an existing bank account or certificate of deposit as collateral for the loan.”

How will taking out a loan help to build a credit history?

When you start making on-time payments, your credit score will start being built as you are demonstrating that you are responsibly committing to your original agreement. If you pay the loan as agreed, the financial institution promises to send a good report to the credit bureaus. But, just as quickly as you can build a good financial reputation, keep in mind that payment more than 30 days late can seriously hurt your score.

How long should I keep my loan?

Expecting an overnight fix will only make you anxious as, in the credit score world, things usually take a little bit of time. Bankrate.com explains that even though it’s not instantaneous, this route is definitely beneficial in the long term. “Although this isn’t a quick fix — personal loans usually take 6 to 12 months to raise your credit score — it does diversify the types of credit on your credit report, and it proves that you can consistently make payments on time.”

So what should be my strategy?

Much like every other financial decision you’ll likely make in your lifetime, we always recommend one thing: talk to a professional! By finding out what your options are, it’ll be much easier for you to take the right steps that will help and not hurt your credit. As a rule of thumb, know that, according to credit bureau agency Experian, to improve your credit score you should:

• Pay your bills on time
• Pay off debt and keep balances low on credit cards and other revolving credit
• Apply for and open new credit accounts only as needed
• Avoid closing unused credit cards
• Avoid applying for too much new credit, resulting in multiple inquiries
• Dispute any inaccuracies on your credit report

Check out the Experian blog post on how to fatten up your thin credit file to learn more best practices for a healthy credit score.

(Note: LendingPoint does not offer specific “credit builder” loans as described above.)