Installment loans can help improve your credit score by adding on-time payment history to your credit report. They can also broaden your credit mix, which is a credit score factor that considers the types of accounts you own, if you primarily used credit cards in the past.
Its important to remember, however, that getting an installment loan may not have an immediate or significant positive effect on your credit and may actually bring scores down in the short term. Responsible account management that includes making consistent, timely payments will promote steady, sustainable growth in your score over time.
Read on for more details about how an installment loan could potentially take your credit to the next level.
Installment loans allow you to borrow a fixed amount of money and repay it in equal monthly payments over a set period of time. Some common types of installment loans are auto loans mortgages and personal loans. But does taking out an installment loan hurt or help your credit? The answer is, it depends.
Installment loans can be useful financial tools when used responsibly. But like any credit product, they need to be approached carefully to avoid damage to your credit score. In this article, we’ll explore how installment loans can impact your credit and provide tips on using them to build your credit history.
How Installment Loans Can Hurt Your Credit
Opening any new credit account, including an installment loan, will cause a hard inquiry on your credit report. Too many hard inquiries in a short period of time can ding your credit score, especially if you open several accounts back to back. Each hard inquiry can knock a few points off your score.
More significantly, missing or late payments on an installment loan can seriously damage your credit. Payment history is the most important factor in your credit score, accounting for 35% of your FICO score.
If you miss payments, it will show up on your credit report and your score will take an immediate hit. A 30-day late payment can knock as much as 100 points off your credit score. The later the payment the more it impacts your score.
Defaulting on an installment loan and having the account sent to collections or charged off as bad debt will also trash your credit scores. You may see your scores drop by 150 points or more. The negative marks can stay on your credit report for 7-10 years depending on the type of debt.
Finally, installment loans can increase your credit utilization if you max out the limit. Credit utilization compares your total balances to your total credit limits on revolving credit accounts like credit cards. Experts recommend keeping your utilization below 30%. Maxing out an installment loan can push your overall utilization over that threshold, resulting in a lower credit score.
How Installment Loans Can Help Your Credit
On the flip side, installment loans can also help build your credit if they are managed properly. Here are some of the beneficial effects they can have:
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Demonstrate responsible borrowing: Paying an installment loan on time every month demonstrates to lenders that you can manage debt responsibly. This will help boost your credit over time.
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Improve credit mix: Credit scoring models like to see a mix of different types of credit on your report, including both installment loans and revolving credit. Adding an installment account can round out your credit profile.
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Lower utilization: If you use an installment loan to consolidate or pay off credit card balances, it can lower your overall credit utilization since installment loan limits aren’t factored into utilization. This can boost your credit score.
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Build payment history: Making on-time payments month after month builds positive payment history for that specific loan account. This gradually helps improve your credit scores as long as you pay as agreed.
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Increase length of credit history: Holding an installment loan long term adds to the average age of your credit accounts, another factor that helps your credit score. The longer you hold accounts in good standing, the better.
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Show ability to manage debt long term: Handling a longer-term installment loan demonstrates you can responsibly manage debt for multiple years, a sign of creditworthiness. Revolving debt doesn’t have the same multi-year track record.
The key is to make sure your installment loans are affordable to you, so you can make the payments reliably every single month while the loan is active. Consistent on-time payments will cause your credit scores to gradually strengthen over the life of the loan.
Tips for Using Installment Loans to Build Credit
If you want to use an installment loan to actively build your credit history, here are some smart tips:
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Only borrow what you can confidently afford to repay based on your budget. Don’t take on more debt than you need.
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Make sure the lender reports your monthly payments to at least one of the three major credit bureaus (Experian, Equifax, and TransUnion). You want the positive history to appear on your credit reports.
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Consider a credit-builder loan specifically designed to help you establish credit history as you repay it. These loans place the money you borrow into a savings account as collateral while you make payments.
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Ask the lender to report the loan as an “installment loan” instead of a “consumer loan” on your credit report. Installment history counts more positively than general consumer credit when scoring models evaluate your credit mix.
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Consider adding a responsible cosigner with good credit or opt for a secured installment loan backed by a deposit if you have limited credit history. This can help with approval odds.
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Automate payments so you never miss a bill deadline. Set up autopay through your bank account or with the lender directly. This guarantees reliably timely payments every month.
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Pay more than the minimum when possible. Paying extra demonstrates good financial management and pays the debt off faster. Just make sure to allocate the extra to the principal.
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Keep credit card balances low while repaying installment debt to avoid high utilization dragging down scores. Let the installment account build positive history without counterbalancing negatives.
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Periodically check your credit reports to ensure the loan is reporting as agreed with the correct payment status each month. Dispute any errors with the credit bureaus.
The most vital factor when using installment loans to build or rebuild credit is making every single payment in full and on time, month after month. This establishes positive history that gradually counteracts past credit mistakes.
Alternatives to Installment Loans for Building Credit
Installment loans aren’t the only path to take when looking to actively strengthen your credit. Here are some other options to consider:
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Secured credit cards: These require a refundable security deposit that also acts as your credit limit. They are easier to qualify for if your credit needs work but still allow you to build history.
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Retail credit cards: Store cards tend to have lower credit requirements. Use them sparingly and pay off balances monthly to avoid hurting your credit utilization.
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Credit-builder loans: Designed specifically to help establish positive payment history, these loans place the money borrowed into a savings account while you repay it.
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Become an authorized user: Ask a family member or friend with a strong credit history to add you as an authorized user on a credit card. Their good account history can boost your credit.
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Credit repair: Work with a reputable credit repair company to identify and dispute mistakes on your credit reports. Removing errors can increase your scores.
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Debt avalanche/snowball: These focused repayment plans target debts one by one to efficiently pay them off and remove them from your credit report.
For major financing needs like buying a car or home repairs, an installment loan may be your best or only option. Just make sure you only borrow what you can realistically manage with your current income and budget. The responsible use of installment loans can be credit-building over time. But taking on excessive installment debt and struggling with payments will do more harm than good.
The Bottom Line
Installment loans can hurt your credit if not managed carefully. Missed payments, defaulting on a loan, or maxing out your available credit can all do damage to your credit scores. However, paying off an installment loan consistently over its multi-year lifespan builds positive history that can benefit your credit profile.
The key is borrowing wisely, choosing affordable loan terms, making reliable on-time payments every single month, and avoiding the temptation to rely solely on installment borrowing to finance your lifestyle. Used prudently as part of an overall healthy credit mix alongside smart credit card habits, installment loans can be a helpful financial tool and credit score booster. Just make sure your eyes are wide open to the pros and cons before signing any loan agreements.
Installment Loans Can Help Raise Your Credit Score
The most important element of your FICO® Score☉ is your payment history. This factor alone accounts for 35% of your score, which is why consistently making all bill payments on time is one of the surest ways to improve and maintain excellent credit.
Because installment loans require monthly payments over an extended period of time, they give you the opportunity to make regular on-time payments that help you improve your score. On the flip side, missing even one payment or paying 30 days or more late will negatively impact your credit score. Choose payment options, like automatic debit, that will reduce the likelihood that you miss paying your bill.
A less weighty, but still important, factor in your score is credit mix. Since the FICO scoring algorithm is chiefly looking for a combination of both installment and revolving credit, adding an installment loan to your credit report when youve only used credit cards, or vice versa, can help give your scores a lift.
Credit mix accounts for 10% of your FICO® Score, so its not as important as other factors. Also, since the potential downsides of taking on credit you cant manage are so consequential, its not advisable to take on new credit solely to improve your credit mix.
What Is an Installment Loan?
An installment loan is a type of credit thats paid off in fixed payments, usually on a monthly basis, over a set repayment term. Typically, unless youve received an intro 0% APR financing deal, youll pay interest to the lender in exchange for paying off the loan over time. The loan can be either secured—that is, its backed by a piece of collateral that the lender can take away if you dont pay—or unsecured. Common installment loans include mortgages, student loans, personal loans and car loans.
Installment loans are different from credit cards, which are a type of revolving credit. Unlike installment credit, a revolving credit account lets you repeatedly borrow money and pay it back over a period of time.
Whereas you might take out an installment loan for $10,000 and pay it back over five years, a credit card would provide you with a credit limit or credit line (for comparisons sake, say $10,000), which you could charge up to as you wish. Youll typically accrue interest on any balances you carry from one billing period to the next.
Installment debt Versus Revolving debt and how they impact your CREDIT SCORE
FAQ
What are the disadvantages of an installment loan?
Does an installment plan affect credit score?
Is paying in installments bad for credit score?
Do installment loans get reported to credit bureaus?
Do installment loans affect your credit score?
An installment loan can help your credit in a big way if you pay as agreed. It might also help in a small way by giving you a better credit mix if you only have credit cards. Here’s what you need to know about how installment loans can affect your credit score. What are installment loans?
Should I get an installment loan?
Finally, an installment loan can help diversify your credit profile and establish credit history. Having multiple lines of credit and a long history of credit shows lenders that you are responsible with your money. Adding an installment loan to your profile can help improve your credit mix — however, don’t go overboard.
Do installment loans help build credit?
Installment loans can help build credit if you are consistently paying on time and the lender reports your activity to one or more of the credit bureaus. The biggest influence on credit scores is payment history, so a record of on-time payments will help your credit, but payments more than 30 days late can seriously damage your score.
Should I get an installment loan if I have a bad credit?
That’s why having a good credit score can help save you money in the long run. If you have a poor credit score and have been denied approval for an installment loan, consider having a co-signer assist you. How do installment loans differ from other types of credit?