The reason credit cards are the go-to method for building credit is that credit card companies report all credit activity to the major credit bureaus — Experian, TransUnion, and Equifax — which, in turn, evaluate your creditworthiness and eligibility. But this approach isn’t exclusive to credit cards. In fact, most types of loans also report account information to the major credit bureaus, allowing you to build credit when you take out a loan.
Credit-Builder Loans
As the name suggests, credit-builder loans exist for the sole purpose of helping you build your credit. The amount you borrow is typically held by the lender in a bank account while you make payments. You won’t have access to the money until you have fully repaid the loan. At that time, you can access the funds, including any interest earned from the savings account. While you’re making on-time payments, your credit is building naturally. These loans are most often offered by credit unions or community banks.
Pros:
- Low-interest rates
- Accessible to those with poor or nonexistent credit
- Low debt burden
Cons:
- Don’t have access to the money right away — need to pay off the loan before you can use the funds
Auto Loans
Auto loans can help increase your credit score when you make on-time payments. Most traditional auto loan dealers report all your payments to the credit bureaus. If you make your loan payments on time, you might be able to positively impact your score. Keep in mind that you will already need some type of credit history in order to qualify for an auto loan. Your credit score can tell you how likely you are to get a car loan and what interest rates you’ll pay.
Pros:
- Increases your credit history — provided you don’t have any late or missed payments, this increase can help build your score
Cons:
- A hard inquiry will be made to your credit report, which could temporarily lower your credit score by a few points
- Higher interest rates
- Less accessible to those with poor or nonexistent credit
Federal Student Loans
Consistent and on-time payments toward federal student loans can improve your credit score. Most federal student loans don’t require any credit history, so they’re a great option if you are just starting your credit journey. You shouldn’t take on student debt just to build your credit, but if you’re already considering a student loan, it could be a good way to begin building a solid credit history. Payments toward your federal student loans are reported to the 3 credit bureaus, and if they’re paid on time, they can help build and improve your credit rating.
Pros:
- Accessible to those with poor or nonexistent credit
- Lower interest rates than private student loans
Cons:
- Missed or late payments on federal student loans could negatively affect your credit score
- High debt burden
Mortgage Loans
Similar to auto loans, mortgage loans are more geared toward those with a preexisting credit history. If your only objective is to start building credit, a mortgage loan may not be the best place to start. However, if you are ready to become a homeowner, then a mortgage loan is a great way to build a positive payment history. Mortgages typically take 15 to 30 years to pay off, which is plenty of time to perfect your score by making on-time payments.
Pros:
- Can positively contribute to the age of your credit, if payments are made on time
Cons:
- Less accessible to those with poor or nonexistent credit
- High debt burden
- A hard inquiry will be made to your credit report, which could temporarily lower your credit score by a few points
Personal Loans
Personal loans can also help build credit, as long as you make payments on time and pay back the loan as soon as possible. Some lenders offer unsecured personal loans to individuals with no or bad credit. Keep in mind that if you don’t have an established credit history, you will likely be charged a higher interest rate. Not all personal lenders report to the major credit bureaus, so if your main motivation is to build credit, make sure to ask the lender if your payment history will be reported.
Pros:
- Accessible to those with poor or nonexistent credit
Cons:
- Potential for high interest rates
- Must be repaid in equal monthly installments — if you can’t make the payments, your credit score will suffer
- A hard inquiry will be made to your credit report, which could temporarily lower your credit score by a few points
