Building your credit can unlock possibilities and save you money. It’ll help you qualify for loans and credit cards at lower interest rates, and you might get a break on your car insurance rate or avoid deposits on utilities.
But be strategic about the approach you pick. Taking on high-cost debt to improve your credit can leave you in a worse place than where you started.
Some approaches to credit-building can backfire
Whether you need to beef up a thin credit history or make up for some missteps, an effective way to build credit is simple: Take out a reasonable amount of credit and pay it back as agreed. On-time payment is the biggest single factor in credit scores.
But it’s hard to qualify for a personal loan or traditional credit card with poor credit — and every application causes a dip in your scores.
If you do find something you can qualify for, it’s likely to carry a high interest rate. That can mean higher payments. Before committing to them, make sure your budget can handle it. If you miss payments, your credit will suffer a big hit — the exact opposite of what you’d been hoping for.
Two safer ways to use debt to build credit
Credit builder loans and secured credit cards are safer bets if you have poor credit. They’re easier to qualify for and tend to have lower interest rates because they have built-in protections for the lender.
Here’s how they work:
- Credit-builder loans: Usually offered by smaller institutions. The money you borrow is put into a savings account and is released to you only once you’ve paid off the loan as agreed. Your credit scores can increase by 30 points within six months by repaying a credit-builder loan as agreed — on time and in full.
- Secured credit cards: A secured credit card requires you to put down a cash deposit, usually equal to your credit limit. The deposit protects the issuer in case you don’t make your payments. That reduces the risk to the issuer, making secured cards an option for people with bad credit or no credit history.
Any time you take on debt to build credit, give yourself the best shot at success.
“Don’t rush into it, as eager as you might be to build credit,” says Chris Dlugozima, education specialist at GreenPath Financial Wellness, a nonprofit credit counseling agency.
He suggests you have a stable income, a realistic budget and at least a small amount in savings. That helps to keep your cash flow steady and counter any emergency that might pop up, so you don’t miss any payments.
“If you don’t have the foundation in place, you might end up doing more damage than you intended,” Dlugozima says.
Tactics to improve your credit
In addition to be being strategic in picking a credit-building tool, follow the best practices to create a healthy credit profile:
- Pay all bills on time: Payment history is the biggest factor in your credit scores
- Keep credit utilization low: Try not to use too much of your available credit. Experts suggest using no more than 30% of the credit limit on any credit card.
- Clean up your credit reports: See if your reports have score-damaging errors. You can use AnnualCreditReport.com to get the free reports you’re entitled to every 12 months. Dispute any inaccurate negative information.
- Track your progress: Monitor your credit score to watch your progress and get feedback on your efforts.