How Installment Loans Can Help You Build Credit From Scratch

Building credit can seem like an impossible task when you’re starting from scratch. With no credit history to show lenders it’s tough to get approved for loans or credit cards that can help build your score. That’s where installment loans come in.

Installment loans allow you to borrow a lump sum of money and repay it in fixed monthly payments over a set period of time. They can be an effective way to establish a payment history, improve your credit mix, and lower your credit utilization – all important factors in building credit.

In this comprehensive guide we’ll explain

• What installment loans are and how they work
• The pros and cons of using installment loans to build credit
• Steps for getting approved with no credit history
• Expert tips to manage installment loans responsibly
• Alternative options for building credit from nothing

What Are Installment Loans?

Installment loans provide access to lump sums of cash, which you pay back in equal monthly payments (installments) over a fixed loan term Common examples include

• Personal loans
• Auto loans
• Student loans
• Mortgages

The set payment amounts and predictable loan terms make installment loans a useful tool for budgeting expenses over time. Interest rates are fixed as well, so your monthly payments remain consistent.

Installment loans differ from revolving credit like credit cards in a few key ways:

• You borrow a single lump sum upfront, not a line of credit
• The loan has defined end date when it will be fully repaid
• You make fixed payments, not minimum payments that fluctuate

For those new to credit, installment loans offer a more structured approach to borrowing and repayment than credit cards provide.

The Pros of Using Installment Loans to Build Credit

When used responsibly, installment loans offer several benefits for building credit from scratch:

1. Establish a Payment History

One of the biggest challenges of building credit with no history is convincing lenders you can handle repayment responsibly. Installment loans allow you to demonstrate this.

As you make consistent on-time payments each month, you begin establishing a positive track record of managing debt. Payment history makes up a major component (35%) of your credit score.

Setting up autopay is a surefire way to never miss installment loan payments. Just be sure the autopay date aligns with your pay schedule.

2. Improve Your Credit Mix

FICO and VantageScore credit scoring models like to see borrowers successfully managing different types of credit, including both installment loans and revolving accounts like credit cards.

Having an installment loan helps diversify your credit mix, demonstrating you can handle different credit products responsibly.

3. Lower Your Utilization

Credit utilization (the ratio of credit used to available credit) is another key factor in credit scoring, making up 30% of your FICO score.

By paying off credit card balances with an installment loan, you can significantly reduce your overall utilization. This can boost your credit scores, provided you don’t rack the credit cards back up.

The Cons of Using Installment Loans to Build Credit

Installment loans aren’t without their downsides, especially for borrowers new to credit. Be aware of these cons before moving forward:

• Missed payments hurt: A single late payment can devastate your scores and undo months of on-time payments. Set up autopay to prevent this.

• Credit checks required: Applying requires a hard credit check, which can lower your score temporarily. Limit applications to a short period to minimize hits.

• Debt load increases: Taking on an installment loan adds to your overall debt burden. Keep loan amounts modest and aligned with budget.

• Prepayment penalties possible: Some installment loans charge fees for paying off early. Understand the fine print before borrowing.

As long as you borrow conservatively and make payments on time, the benefits typically outweigh the risks when building credit. But entering into an installment loan irresponsibly can set your credit-building efforts back.

Getting Approved for Installment Loans With No Credit

Securing your first installment loan with no prior credit can prove challenging. Most lenders view borrowers with limited credit histories as higher risk.

But it is possible with careful preparation and by targeting lenders who offer loans to those rebuilding credit. Here are some tips:

• Check reports for errors: Mistakes on your credit reports can sabotage approval odds. Scan reports closely and dispute errors with bureaus.

• Ask about “newcomer” programs: Some credit unions and community banks offer installment loans to help members build credit.

• Try a secured loan: Putting up collateral, like in a secured credit card, gives lenders added protection when approving those with limited credit history.

• Bring pay stubs to demonstrate income: With no credit file, lenders look closely at your income and expenses to assess risk. Bring evidence you can afford payments.

• Apply with a coborrower: Adding someone with established credit as a joint applicant improves the chances of getting approved. Just make sure they make payments on time too.

• Start small: Lenders are more willing to take a chance on borrowers with no credit when loan amounts are modest. Keep your first installment loan under $5,000.

Persistence and patience are critical when seeking your first installment loan. But once approved, be absolutely diligent about making monthly payments on time.

Expert Tips for Managing Installment Loans to Build Credit

Installment loans only help build credit if managed properly. Follow these expert tips for using them effectively:

• Make payments on time every month – set up autopay if it helps.
• Keep loan terms short (2 years or less). You build credit faster repaying quicker.
• Don’t take the full term to repay – pay down principal faster if you can.
• Apply for loan amounts you can realistically afford to repay.
• Be mindful of interest rates and fees – cheaper financing leaves more money for paying principal.
• Avoid opening too many new credit accounts too quickly.
• Use installment loan funds only for planned expenses, not unnecessary purchases.
• Check credit reports regularly to make sure on-time payments are being reported.
• Contact the lender immediately if you anticipate payment issues or need to adjust due dates.

Following these tips will ensure your installment loan has the best chance of helping build your credit history responsibly.

Alternative Options for Building Credit from Scratch

While they can be useful, installment loans aren’t your only option for building credit with no history. Some alternatives worth considering include:

• Secured credit cards – These require a refundable security deposit that serves as your credit limit. Use responsibly, make monthly payments in full.

• Retail store credit cards – Easier to get approved for, but must be used carefully and sparingly. Pay off balances monthly.

• Credit builder loans – Designed specifically for establishing payment history. Funds sit in savings account while you make monthly payments.

• Authorized user status – Get added as authorized user on someone else’s credit card. Their payment history gets added to your credit reports.

• Report rent to credit bureaus – Services like RentReporters let you build payment history by reporting on-time rent payments to credit bureaus each month.

• DIY credit letters – Write letters to creditors demonstrating you can manage payments responsibly and ask to get reported.

Building credit takes diligence, restraint, and patience regardless of whether you use installment loans or another method. The key is using credit wisely and making on-time payments consistently over time.

The Bottom Line

As you start from scratch, installment loans can be an effective tool for establishing a solid payment history and diversifying your credit mix. Both are critical to building credit.

However, installment loans aren’t guaranteed to raise your score. Borrow conservatively, make payments on time, keep balances low, and have a plan for repayment. With responsible use, they can kickstart your credit journey.