Having credit scores in the good to excellent range is important for securing a home or auto loan that has lower interest rates and more favorable terms. Some of the most common ways to build your credit include taking out a credit card or student loan and then making the monthly payments in full and on time. Another lesser-known option is to purchase a CD and then take out a secured loan against the CD. As you pay back the loan, your credit score will increase.
TL;DR (Too Long; Didn't Read)
While taking out a CD alone doesn't build your credit, you can obtain a secured loan against that CD to help raise your credit score over time.
What Is a CD?
A certificate of deposit, or CD for short, resembles a type of savings account and can be issued by a variety of financial institutions. The difference between a savings account and a CD is that the CD comes with a fixed term and a fixed interest rate. You may purchase a CD that lasts one month, 10 years or a period of time in between these terms. If the interest rate is 3 percent at the time of purchase, it will remain 3 percent for the duration of the term.
Since CDs are insured by Federal Deposit Insurance Corp. (FDIC) and the National Credit Union Association (NCUA), you don't have to worry about losing your investment.
Getting a CD Secured Loan
Contact the bank or credit union that currently holds your CD and request a CD secured loan. It is important that you make sure this financial institution reports all personal loans to the three major credit reporting agencies, so you can build your credit.
You won't need to provide any collateral when taking out the loan since the CD will act as the collateral. The loan amount will match the amount you deposited in the CD. As with any loan, you'll need to review the repayment terms and make sure you agree to them before signing on the dotted line.
Improving Your Credit Score
When you receive the loan funds, set them aside so you can use them to make your monthly payments. Then begin repaying the secure CD loan on the date specified in your contract. Pay careful attention that you never miss a payment or send the payment later than its due date. According to Equifax, if you make even one of your CD loan payments late, your credit score can suffer by as much as 90-to-110 points.
By the time you finish paying off the loan, you'll see an improvement in your credit score. You can repeat the process to further demonstrate your ability to pay on time and in full.
- CD-secured loans may not the best idea if you have other options such as a secured credit card. The money you are earning from the CD interest will be partly offset by the interest you will be paying on the loan.
Alicia Bodine is a New Jersey-based writer specializing in finance. With more than 13 years of experience, her work has appeared in LendingTree, GoBankingRates, Sapling, Zacks and Pocket Sense.