You have to have credit to get credit
No matter how much you may not like debt, even if all you ever want to do is buy a house someday, or a new car with credit, you have to already have credit to get the new credit. I am asked all the time “what is the best way to build credit?”. The best way is to have at least a couple of open credit cards with at least a 12-month history. If you don’t have any credit, or your scores are too low you can get a secured credit card. However, an often overlooked very effective method of building credit is by getting a CD-secured loan. The best part of this method is you don’t actually go into debt to do it. What is a CD?
I suggest going to your bank where you have an account with a financial banking history, first. If you prefer to go somewhere different, then credit unions are usually the most CD-loan friendly. When my 18-year old daughter wanted to start building credit she went to our local Educational Employees Credit Union (no affiliation), opened a checking account, then proceeded to get a CD-secured loan. Search the internet for credit unions in your area, or ask around for for the best options. In order to save time, pick up the phone and call, asking if they offer CD-secured loans, and what their requirements are.
Here is how it works:
1. Find out the minimum amount required for opening a CD. Every place is different. For the purposes of building credit it doesn’t matter how big the CD or loan is, just that you make your payments on time. In my daughter’s case she only needed $500 to open a CD, actually opened two of them.
2. After the CD is set and the certificate in your hands, walk directly over to the loan department and tell the loan officer you want to open up a CD-secured loan. She will know what you are talking about. Borrow the same amount of the CD, dollar for dollar. The CD secures (backs) the loan in the case of default and since it is almost like cash and at the same bank as the loan, easy to liquidate in the case of default – which you are not going to let happen, right?
3. Take the loan proceeds and put it in an account at the same bank with auto draft set up for making the loan payments. Again, the loan officer and any banker will know how to set that up for you. It is a common procedure. At the end of the loan term your loan is paid off, and you still have the money in the CD earning interest. Granted, these days, CD rates are not very attractive, but remember, the purpose is to build credit.
Tip: You can ask the loan officer to amortize the loan for 3 years with a balloon note (when the loan note is due) for 12 or 18 months in order to lower your payments if necessary. Keep in mind, though, that this means the loan will still have a balance at the end of the loan term. (Definition of amortization)
The key to this method of building credit is that you don’t go into more debt, per se. You are using your own money to build credit. Also, the interest rate is only 2% above the CD rate. For example, if you are earning 1% on your CD, you only pay 3% on your loan.
Note: This type of loan is an installment loan. Go here for a definition of an installment loan. There are only three types of loans: installment, revolving and mortgage. FICO likes to see all three on your credit report for a good mix of credit.
There you go. If you need to build better credit, new credit, or even recover from a bankruptcy, a CD loan is one of the best ways to add credit history showing you can pay back an installment type loan. Good luck!
By Blair Warner, Sr. Credit ConsultantCategory : credit, Credit Building