A guide to loans and credit involves understanding the different types of loans available, how your credit is established and scored, and strategies for maintaining good credit health
. Types of loans
Secured vs. unsecured loans
The main distinction between loans is whether they are secured with collateral or not.
- Secured loans: These require you to pledge an asset, such as a house or car, as collateral. Because this reduces risk for the lender, secured loans often come with lower interest rates.
- Examples: Mortgages, auto loans, and home equity loans.
- Unsecured loans: These are not backed by collateral. Your eligibility and interest rate are based on your credit history and income, so they typically have higher interest rates than secured loans.
- Examples: Personal loans, student loans, and most credit cards.
Common loan types
- Personal loans: Used for a wide variety of purposes, from consolidating debt to financing a wedding or home renovation.
- Mortgage loans: These loans finance the purchase of a home. They can have fixed or variable interest rates and different repayment terms.
- Auto loans: Used to purchase a vehicle, with the car itself serving as collateral.
- Student loans: These help pay for higher education expenses.
- Debt consolidation loans: A type of personal loan used to combine multiple high-interest debts into a single loan with a lower interest rate.
- Home equity loans: Allows you to borrow a lump sum against the equity in your home.
- Credit-builder loans: Designed to help those with little to no credit history build a positive credit report.
- Payday loans: These are high-cost, short-term loans that should generally be avoided due to extremely high interest rates.
The importance of your credit score
Your credit score is a three-digit number that represents your creditworthiness. A higher score qualifies you for lower interest rates and better loan terms. The most common scoring models are FICO and VantageScore, and a "good" score generally falls in the 670–739 range.
How your credit score is calculated:
- Payment history (35%): Making payments on time is the most important factor.
- Credit utilization (30%): How much of your available credit you are using. It is best to keep this below 30%.
- Length of credit history (15%): A longer history of responsible credit use is better for your score.
- Credit mix (10%): Having a mix of different types of credit (e.g., credit cards and installment loans) shows that you can manage various forms of debt.
- New credit (10%): Applying for too much new credit in a short period can lower your score.
Understanding and monitoring your credit report
Your credit report is a detailed record of your credit history compiled by the three major credit bureaus: Equifax, Experian, and TransUnion. It contains personal information, a list of your credit accounts, and credit inquiries.
How to get your credit report
You can get a free copy of your credit report from each of the three major bureaus weekly by visiting AnnualCreditReport.com.
Why you should check your report
- Check for errors: Mistakes can hurt your score, so you should dispute any inaccuracies you find.
- Monitor for fraud: Regular checks can help you detect signs of identity theft early.
Tips for building and improving your credit
- Pay your bills on time: Make at least the minimum payment by the due date every month. Consider setting up automatic payments to avoid missing a due date.
- Keep credit card balances low: Aim to keep your credit utilization below 30% of your total credit limit. You can make multiple small payments throughout the month to help achieve this.
- Maintain old accounts: The age of your credit accounts is a factor in your score, so avoid closing older accounts, especially those without an annual fee.
- Borrow what you need: Only apply for new credit when you need it. Shopping for a single loan, like a mortgage or auto loan, within a concentrated period will not hurt your score as much as multiple unrelated credit applications.
- Create a credit mix: Responsibly manage different types of credit, such as credit cards and installment loans, to improve your score over time.
AI responses may include mistakes. For financial advice, consult a professional. Learn more