In this article:
A secured loan can help you build credit if you make all payments on time, but since secured loans are backed by collateral, you risk losing a valuable asset if you miss payments. There are other products that can help you build credit without as much risk.
Still, in the case of personal loans, if a secured loan is the right choice for you, it may be easier to get than an unsecured loan. And since a loan backed by collateral presents less financial risk to a lender, you may be offered a lower interest rate as a result. Here's what to know.
What Is a Secured Loan?
A secured loan is backed by collateral, which is an asset that acts as a guarantee against the money you borrow. If you miss payments and default on your loan, the lender is able to take possession of your collateral to cover their financial loss.
Auto loans, mortgages and home equity loans are common types of secured loans. When you get an auto loan, your car is the collateral; for home equity loans and mortgages, the collateral is your home. There are also secured personal loans.
When you receive a secured loan, you'll typically make a fixed monthly payment to the lender that includes the principal and interest at the annual percentage rate (APR) you've been approved for. You'll make payments according to the loan's term. Auto loans often have terms from 48 to 84 months, and mortgages from 15 to 30 years. Personal loan terms can extend from one to seven years.
Note: When the loan is paid off, the account and your payment history can remain on your credit report for up to 10 years if the account was closed in good standing (meaning you made all payments on time).
Can a Secured Loan Help You Build Credit?
A secured loan can help you build credit as long as you make on-time payments. Payment history accounts for 35% of your FICO® Score☉ Θ, making it the most significant single factor that impacts your creditworthiness. On the flip side, negative marks associated with the account, including late payments, will stay on your credit report for up to seven years. Before taking out a secured loan, budget for your monthly loan payments to help you avoid damaging your credit.
Are Secured Loans a Good Idea?
A secured loan can be a good idea if you:
- Have a true need for the loan: Choose a secured loan if it helps you meet other financial goals and is not merely a means to build credit. (Credit-builder loans, however, are a type of loan that are reasonable to opt for solely for credit-improvement purposes.)
- Are willing to take on the risk of losing an asset: You'll need to secure the loan with collateral, which can include cash in a savings account, a car, a home, stocks, bonds and more, depending on the type of loan you choose. Opting for a secured loan means accepting there's a risk you'll lose that asset if you can't keep up with loan payments.
- Can easily fit the monthly payment into your budget: Use a loan calculator to determine exactly how much your monthly payment will be, and check whether it's affordable based on your current income and expenses.
- Have an emergency fund: Plan to build an emergency fund of at least three months' worth of essential expenses. You can then draw on those funds if you lose your job or other difficult circumstances arise and you need to cover loan payments on less income.
- Choose a relatively short loan term: Go for a secured loan only if you can qualify for a loan term that's not too long. That limits the risk that your financial situation will worsen while you're repaying the loan, and thus the risk that the lender could seize your collateral.
- Have experience with credit: If you currently successfully manage another loan or credit card, taking on a secured loan may be less of a risk since you already have the experience of fitting monthly payments into your budget and making them on time.
How to Get a Secured Loan
The process for getting a secured loan, and the eligibility requirements you'll need to meet, vary by loan type. But in general, start the process by comparing multiple loan offers, known as rate shopping, to ensure you choose the option with the lowest interest rate available. You'll typically apply for the loan directly with the lender, and you may need to provide information about your income, current debt payments, housing costs and more.
You'll also undergo a credit check, and the lender may have minimum credit requirements. You may be able to get prequalified for certain loans, which can help you compare offers before going through the full application process. A secured loan generally has less strict requirements for credit scores than an unsecured loan, and could come with higher loan limits.
Once you've been approved, you'll receive a disbursement of the loan and will generally start repaying right away according to the loan terms. It's best to send your monthly bill to the lender with autopay so you never miss a payment.
Additional Ways to Build Credit
If a secured loan isn't right for you, there are other ways to build credit. Try these strategies:
- Get a secured credit card. Like a secured loan, a secured credit card requires collateral. In this case it's a cash deposit, which in turn will likely be equivalent to your credit limit. If you don't pay your bill, your card issuer will keep some or all of your deposit—and your credit score can take a hit as well. If you keep up with payments, some credit card issuers will return the deposit to you and convert your account to a traditional unsecured card after you've made a number of on-time payments.
- Become an authorized user on a credit card. Ask to be added to a trusted family member's or friend's credit card account as an authorized user. Typically, that person's credit limit and payment history will appear on your credit report, but you won't be liable for the payments or any resulting debt. This strategy generally works best if you're new to credit and if the primary cardholder has good or excellent credit scores.
- Apply for a loan with a cosigner. If you won't qualify for a loan on your own, you can apply with the help of a cosigner, who will be responsible for the debt if you can't pay. That person's more established credit history can help you get approved for a loan or get a lower interest rate. But it's important that they're comfortable with the loan showing up on their credit reports, too, and with taking on payment responsibility if you can't afford your loan bills.
- Get credit for on-time bill payments. Experian Boost®ø®ø is a free feature that can help you increase your FICO® Score based on your Experian credit report. It adds eligible utility, phone, rent, insurance and some streaming service payments to your credit report, which could help you build your credit if you don't have much experience with credit or are looking to improve your score.
- Consider a credit-builder loan. With a credit-builder loan, the lender deposits its own funds into a savings account, and you make fixed payments for a period of months. When the loan is satisfied, the lender will give you the total balance of the savings account, which may include a portion of the interest you paid or that grew in the account. This allows you to save money and build credit simultaneously. Make sure the lender reports your payments to all three credit bureaus (Experian, TransUnion and Equifax), which could improve your credit by strengthening your payment history.
Learn more: How to Build Credit: A Comprehensive Guide
Frequently Asked Questions
What Credit Score Do You Need to Get a Secured Loan?
The credit score you need depends on the loan type. Secured personal loan credit requirements vary by lender, but some loans have no credit score minimum. The same goes for auto loans. You'll typically need credit scores of at least 620 for a conventional mortgage. In general, the higher your credit scores, the higher the likelihood you'll get lower interest rates and better loan terms.
Can a Secured Loan Hurt Your Credit?
A secured loan can hurt your credit because a hard inquiry will be added to your credit report upon applying for the loan, which can cause a small, temporary score drop. Beyond that, late or missed payments on the account can also harm your credit. But making all payments on time can strengthen your credit over time.
Is a Secured or an Unsecured Loan Better for Building Credit?
There's no difference in the impact to your credit between a secured loan and an unsecured loan. Both can build your credit if you always make on-time payments, and both can hurt your credit if you don't. The main differences are that a secured loan may be easier to qualify for, but also comes with the possibility that the lender will seize your collateral if you can't repay the debt.
The Bottom Line
A secured loan can help you build credit when you make every monthly payment on time. It's a worthwhile option if getting one is the only way you'll be able to meet a particular financial goal.
But since getting a secured loan is a big commitment, ensure that you truly need the loan and that it serves a purpose beyond helping you build credit. Otherwise, there are several additional options for bolstering your credit scores, such as credit-builder loans and secured credit cards, that won't have such a large potential impact on your finances.