Your credit score is determined by the following factors:
- Payment History (35%)
- Credit Utilization (30%)
- Credit History (15%)
- New Credit (10%)
- Credit Mix (10%)
In this article, I will explain how an installment loan can improve your credit mix, credit utilization, and your overall credit score.
Installment Loans and Your Credit Score
There are two main types of credit – revolving lines of credit (credit cards) and installment loans (any loan that requires regular periodic payments, including auto, mortgage, student, personal, and business loans). A mixture of installment and revolving credit accounts is preferred in the FICO credit scoring model.
Aside from directly improving your credit mix, installment loans also play an important role in your credit utilization. Installment loan utilization is calculated separately from revolving loan utilization, and maintaining a low-balance installment loan will have a positive impact on your credit utilization over time.
Like revolving lines of credit, installment loans will also impact your payment history and length of credit history. However, there are no particular advantages provided by installment loans within these credit scoring factors.
Who Should Obtain an Installment Loan?
If you have an open installment loan and a record of timely payments, there is little reason to establish another loan. You have already captured the credit benefits described above and the remainder of this article will not apply.
If you have a closed installment loan still showing on your credit report (closed accounts with a positive payment history remain on your credit report for 10 years), you can expect a new installment loan to improve your credit, although the impact will be less than someone with no installment loan history.
If you have an open or closed installment loan with negative remarks (closed accounts with negative payment remarks remain on your credit report for 7 years), establishing a new loan and maintaining a positive payment record can boost your credit score by a large margin.
If your credit report is void of all installment loan information, you can expect a nice credit score boost by obtaining a new installment loan.
How to Build Credit Using an Installment Loan
After substantial research on the subject, I’ve found three low-cost methods that can be used to establish a new installment loan.
Option #1) Find a loan that you need
If you are thinking about obtaining an installment loan (mortgage, HELOC, auto loan, business loan, student loan, or personal loan) in the near future, don’t go out of your way to establish one today. Multiple installment loans provide very little additional credit benefit.
If you don’t require an installment loan for an upcoming life event, consider another option listed below.
Option #2) Alliant credit-builder installment loan
First reported on the myFICO forums, you can obtain a 5-year installment loan through Alliant Credit Union using the following steps.
- Join the Alliant Credit Union. Only select groups are eligible, but anyone can join by making a $10 donation to Foster Care to Success.
- Open an Alliant savings account and fund with $510.
- Wait a few days for the money to settle and become available.
- Apply for a $500, 60-month Savings Secure Loan.
- After the loan funds, pay down the loan and leave a $45 remaining balance.
- Make tiny automated loan payments every couple of months to keep the loan active.
- As the loan nears completion, pay the remaining balance and close the loan.
The loan itself is secured by the money in your Alliant savings account, which means that if you default on the loan, Alliant will happily confiscate the funds in your savings account. Because the loan is guaranteed by your savings account, Alliant doesn’t require a hard credit inquiry to open the installment loan.
The loan is mostly paid off in the first month for two reasons. First, you avoid paying interest on the prepaid portion of the loan balance. The accrued interest is based on the $45 remaining balance for the life of the loan. More importantly, a loan balance of roughly $45 means that your installment loan utilization will remain below 10% for the life of the loan (an important factor in the FICO credit scoring model).
The loan is reported on your credit reports for the entire 60-month duration (although it can take a few months to first be reported), and the entire cost is less than $20. The only downside is that you need $500 in cash to get started.
Option #3) Self Lender credit-builder installment loan
Self Lender offers a $550 credit builder installment loan. There are larger loan amounts available, but bigger loans won’t improve your credit score any quicker.
Here is how it works:
- You pay $12 upfront to establish the Self Lender credit builder account
- The Self Lender banking partner (Austin Capital Bank) lends you $550 that is held in a FDIC insured, certificate of deposit bank account (“CD account”) for 12 months. You cannot access the money during this 12-month window.
- You make one $48.50 payment per month to pay down the loan.
- After 12 months, you’ve paid off the loan and the $550 CD is yours to withdraw.
Self Lender handles all of the details for you, which is one of the main selling points, and the entire process will cost you about $44 out of pocket.
You pay the $12 origination fee + $32 of interest (calculated as $582 in total payments ($48.50*12) – $550 received after 12 months)
Self Lender is slightly more expensive than Alliant but easier to establish without the initial $500 upfront deposit. The loan period is 12 months, instead of 60, which means that the installment loan information will not stay on your credit reports for as long. But keep in mind, closed accounts with a positive payment history are reported for 10 years, so the length of loan might not matter if you anticipate needing a future installment loan before the 10-year window expires.
My Installment Loan Plan
I have closed student loan information that is still included in my credit report, but I’m currently in the process of establishing the Alliant installment loan and will update this post with any important findings.
Hundreds of individuals in the myFICO forums have reported a 30-35 point credit score increase after obtaining their first installment loan. Because I already have installment loan information showing on my credit, I anticipate a smaller, but meaningful increase.
It’s also worth noting, other financial institutions offer credit-builder installment loans, but many will require a hard credit inquiry before establishing the account. If you have experience obtaining a secured installment loan from other financial institutions, please share with a comment below.