Why a Credit Card Alone Might Not Be Enough to Build Your Credit

Why a Credit Card Alone Might Not Be Enough to Build Your Credit article image.

Anyone trying to build their credit for the first time tends to hear the same wisdom: Sign up for a credit card. That's usually a wise thing to do, but there are more actions you can take to bulk up your credit file.

Relying only on credit cards to build credit is like relying entirely on concrete to build a new house. It can get you part of the way there, but ultimately you need other materials, too, if you want to finish building a home.

Don't Ignore Credit Mix When Building Credit

There are multiple factors that make up a credit score:

  • Payment history
  • Amounts owed
  • Length of credit history
  • Credit mix
  • New credit

Credit mix, or types of credit, considers the kinds of debt you've taken on, such as installment loans and revolving lines of credit. Lenders like to see that you're a versatile borrower, so credit mix accounts for 10% of your credit score.

Revolving credit, such as credit cards, can revolve with or without a balance on an ongoing basis. Credit cards offer flexibility because you can use them up to the maximum credit limit—or not at all. Revolving credit generally requires a minimum monthly payment, but other than that you can pay off as much or as little as you'd like.

Installment loans, on the other hand, have a fixed schedule of payments over a predetermined length of time. Once the loan is taken out, the borrower is obligated to make payments according to the payment schedule.

Examples of installment loans include mortgages, auto loans and personal loans.

To lenders, a diverse mix of installment loans and revolving lines of credit indicates you can responsibly handle both types of products. For example, if you apply for a loan like a mortgage, the lender will want to see how you've handled other installment loans, and whether you can pay a fixed amount back on a regular schedule.

If you've only had credit cards and not installment loans on your credit report, you may have a harder time getting approved or getting a low interest rate.

The Right Loan Could Help You Build Credit

As long as a loan reports to the credit bureaus, it could help you build credit, but not all loans are created equal.

For example, many "buy here, pay here" car dealers and payday lenders don't report to the credit bureaus. This means any on-time payment history won't be visible on your credit report.

The catch is, to get approved for a loan that does report to the credit bureaus, you usually need a positive credit history or, barring that, a cosigner. If you don't have a cosigner, but you're looking to build your credit and improve your credit mix with an installment loan, you may want to check out credit-builder loans.

Building Credit With a Credit-Builder Loan

A credit-builder loan is a product specifically designed to help people who have little or no positive credit history build their credit. You can find these loans online, through a local credit union or through a community bank.

With credit-builder loans, borrowers make payments into a bank account held by the lender, and when the final payment is made, the money inside that account is returned to the borrower, minus interest and fees. You do not get the money upfront.

The length of these loan types vary anywhere from about six months to three years. Compared with other borrowing options for people with bad or no credit, the interest rates on credit-builder loans are relatively low.

Ultimately, credit-builder loans could help diversify your credit by adding an installment line to your mix.

It's Not Just a Loan, It's How You Use It

Loans by themselves don't help you build credit—you also have to manage them responsibly. Since installment loans have a set payment due date each month where you owe a fixed amount, you have to pay it on time and in full every time.

This on-time payment history accounts for 35% of your credit score and is the most important factor.

Even just one missed or late payment could stay on your credit report for seven years or more and negatively impact your score.

Bottom line? Adding an installment loan to your credit mix could help your credit, but only if you use it well.

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