A secured equity loan can be a good place to start if you are looking to build your credit.
These loans fall into a category of loans known as credit building loans, and despite their names, they are less about lending money and more about helping you build credit.
Equity secured loans are products of credit unions, where accounts are often referred to as equity accounts to represent partial ownership. Savings-backed loans are a comparable banking product, and both work the same way as CD-backed loans.
How they work
The money in your credit union stock account is used as collateral for the loan and serves as a guarantee to the credit union that you will repay the loan. If you don’t pay, the credit union can seize the money in your stock account, according to Justin Pritchard, a certified financial planner with Approach Financial in Montrose, Colorado. Equity backed loans are only available from credit unions.
Credit unions operate similarly to banks, but have memberships with certain eligibility requirements – often based on employer and geography. There are also online-only credit unions that can be joined for a small fee or donation. The National Credit Union Administration has a directory of credit unions so you can find credit unions in your area.
Stock accounts are like savings accounts, so you can also earn interest on funds in your account, although all money in the account is frozen if you take out a loan backed by stocks. Make sure you don’t need this money for the duration of your loan repayment.
After taking out a loan secured by equity, it is important to make payments on time to improve your credit as much as possible, and to report this positive payment history to the credit bureaus.
Look for the best stock account rates at local credit unions near you.
Although the credit union often lends up to the entire amount of money in your account, “that’s not the point. It’s probably going to be a small loan that will help improve your credit so that down the road you can get better loans when you’re trying to buy a car or a house or something like that, ”says Pritchard.
In fact, if your goal is to build credit, it’s best to keep it smaller.
“You don’t have to spend tons of money and pay interest on a huge loan when you’re not earning a lot of interest,” says Pritchard. “I don’t think it improves your credit any further if you borrow $ 10,000 instead of $ 200, so keep it as small as possible so these payments get reported to the credit bureaus.”
Why Use Secured Equity Loans
As a credit loan, equity-backed loans have rather narrow use cases. While they can be great ways to build your credit score, they’re not the best option for those in need of cash, despite the name that includes “loan”. Here are two main reasons why a secured equity loan can make sense:
- To create credit: Making your loan payments on time and in full will improve your credit score.
- Save on your future loans: a positive credit score will be important when applying for larger loans, such as a mortgage or car loan. You can get a better rate if you have a better credit rating.
Who are they for?
Before you begin, make sure that taking out a credit loan aligns with your financial goals. For those with financial problems, and especially those who are already struggling to repay other loans and debts, taking out this type of loan “doesn’t make sense,” says William Hatton, CFP at Billfold Budget Counseling at Los Angeles.
Adding another loan on top of it is not the solution, especially if the interest you earn on the equity account is significantly less than the interest rate on the loan.
“It’s not for people in difficult circumstances,” Hatton says. “If you are getting out of debt, however, and you’ve crossed the corner, then this might be something to consider. But first make sure you have a good savings base before you lock in your money. “
These loans should really be used to build credit. If you don’t need to create credit, you can probably get a better rate and a better loan amount by using another product, like a personal loan or even a credit card in some cases.