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Want To Improve Your Credit Score? What Should You Know About Installment Loans?

If your credit score has dropped after a few missed payments or other negative reports -- or if you've recently graduated or gotten your first job and don't yet have credit -- you may be wondering what you can do to increase your score. Not only can a low credit score impact your ability to purchase a home or a new car, it can even cause your auto insurance rates to rise. Read on to learn more about installment loans and other ways you can quickly improve your credit score.

What are installment loans?

"Installment loan" refers to any type of loan that has a regular payment based on a solid cash figure amortized over a number of months or years. The most common types of installment loans are home mortgages or equity loans, auto loans, and student loans. In each case, the total amount borrowed is multiplied by a fixed interest rate and the total is divided by the payment term.

In contrast, a "revolving loan" refers to a credit card or other type of debt that has variable payments depending on how much you spend at any given time.

How can installment loans improve your credit?

Although you might be tempted to pre-pay any debt to improve your monthly cash flow in the future, doing this could actually hurt your credit score. If your installment loan is reported to the credit bureaus for only a short period of time, this brief report may not be sufficient to cause your score to move much. In most cases, the credit bureau will want to see that you have a demonstrated history of timely payments before raising your score to a range that could qualify you for additional credit offers.

In some cases, particularly if you've just exited bankruptcy or a foreclosure, you may find it takes a while for your score to rise enough for you to be approved for a new installment loan. This results in somewhat of a catch-22 -- getting a loan can improve your credit quickly, but your credit score is not high enough to get a loan.

However, if you have a pre-existing loan that survived bankruptcy (such as a student loan), or you simply have no credit, you may find that making timely payments on an installment loan can start improving your score in as soon as one or two reporting cycles (generally 30 to 60 days). As you continue to make timely payments, your score will rise a bit each month. You should take advantage of the free annual credit reports available to ensure that your credit report remains accurate and free from errors.

What are some other ways to improve your credit score?

A good credit score often depends on a mix of debt types. Although the actual formula used by the credit reporting agencies is top-secret, most advisers indicate that the best credit scores are held by those who have installment loans and revolving loans along with a history of timely payment. For example, an individual who has student loans, an auto loan, and a credit card may have a higher credit score than an individual who has only an auto loan -- as long as both individuals have relatively low debt and on-time payments.

However, you shouldn't use this calculation as a reason to live beyond your means -- any debt obtained should be done as part of your overall financial plan, not as an attempt to pay interest or improve your credit. Even if the only entity reporting to the credit bureau on your behalf is the local utility provider, as long as you make all monthly payments in a timely manner, your credit score will improve over time.