Your Good Name: Build Credit With Loans & CD’s

Here’s a method from Wikihow on building up your credit and creating credit references.

1. Purchase a certificate of deposit (CD) in 3 banks.
2. Take out a loan from each bank for the amount of the CD. Secure the loan with the CD.
3. Place the loan monies in an interest-bearing account, such as a high-yield savings account.
4. Slowly pay down the loans each month.

Does this method work? Are there possible pitfalls to watch out for?— BEN POPKEN

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  1. Nifle says:

    Pros – Build good credit with secure credit. It gives lenders confidence in you that you’re willing to put up your own money to garner a first time loan. If a bank was to entrust a non/poor creditor with no/poor credit history, obviously they are putting themselves in a riskier position. Also, the Fair Isaacs credit rating system weights secure loans higher than unsecure loans (unless unsecure loans have been open for greater than two years with no balance).

    Con- The bank could put a variable rate on the monetarily secure loan that reflects current treasury rates. Or, if CD rates were to jump considerably, the depositor could lose out on valuable interest, if he or she had not retained the loan proceeds.

    The slow pay back shows the ability and willingness to pay a loan on time.

  2. Law-Vol says:

    Works wonders!

    The standard practice for banks is to charge the CD Rate +2% for the loan. On balance, your money isn’t growing as fast as it otherwise might. The upside, however, may be worth a little near-term interest hit.

    My dad has used this method for years and his latest FICO/Beacon rating fell in the upper 820’s–850 is perfect.

    Occasionally, credit cards will offer very low interest cash advances, treated effectively as balance transfers. Using one of these offers in combination with a high-interest savings account (a la ING’s “Orange” account) can also be a very effective method for increasing credit scores, especially because of the high emphasis the FICO formula puts on revolving credit.

  3. humphrmi says:

    This is an old method of securing credit, I first heard about this 20 years ago. Someone actually taught me this as a way to build up your credit enough that you can “buy a house” on a “sig loan” (unsecured loan.) Hogwash. A couple of points:

    1. You will likely only build credit with the institution(s) that you are dealing with. And for big-ticket loans, they are still going to pull your FICO score and decide based on that.

    2. If you already have loans, credit cards, etc., you will likely see your credit score drop as you get overextended with the new loans.

    3. You will pay for the privilege of doing this – you will never make as much money on either the CD’s or the interest bearing checking account as you pay on the loans. And even if the interest from *both* cover your finance charges, that’s still money you lose – because you could just be making interest off the CD’s you invested in.

    There are lots of tricks out there to “build” or “rebuild” your credit, I’ve found that the best trick is to be careful and pay everything on time and don’t go nuts with credit. The less you need it, the higher your score goes.

  4. Joe Hass says:

    Humphrmi:

    It doesn’t work for “credit repair/improvement,” but it works wonderfully for first-timers. It’s how I got started (p.s. thanks for the help, Mom!)

    The objective is to get something on there. This does the trick.

  5. thrillhouse says:

    Yao! This is not a plan.

    A CD is a Certificate of Deposit. Basically, a savings account that you cannot touch until the maturity date – and that date only. If you miss it, forget, or whatever it rolls over for another term. You’re pretty much going to end up shuffling more paperwork around than its worth.

    Why a consumer advocate blog would be interested in building credit in the first place is what I don’t get. you’ll spend more money ‘building your credit’ than you’ll ever save in interest.

  6. nweaver says:

    If you want to build credit as a first timer, get a credit card and PAY IT ON TIME WITH 0 balance. Just keep that up and don’t worry.

    Its probably NOT worth losing 2%+/year on a bunch of money to “inflate your credit score”.

  7. wikkit says:

    I am a “first timer” (I’m in my early 20’s and haven’t yet bought a house) and it IS worth it to me to lose 2% a year on some money in order to build a credit score.

    I have a good credit history, but it takes time to build a good credit score, even with good money management. Without a high credit score it costs me real money down the road on higher car and mortgage payments. I’m all ears to any plan to build that score in a legitimate way, even if it costs me a little up-front.

    Don’t be so quick to scoff at credit building advice, its hard to get your foot in the door.

  8. Triteon says:

    The objective is to get something on there. This does the trick.
    Yep. My bank, United Missouri Bank, told me this. In not qualifying for a mortgage due to having no credit history– you see, I live in the U.S. and by living within my means, not accumulating debt and saving money I am a bad credit risk–my loan officer told me to 1) apply for a low-limit credit card, 2) by a tank of gas, 3) pay off the card. Poof! Charging $20 worth of gasoline gives me enough credit history to get a six-figure mortgage!

  9. Baz L says:

    Some of us can’t get credit cards without credit in the first place.

    This is not about making money or interest. It’s about being 20 years old with no one to co-sign on a long for you and you can’t even get a Sears card.

    Who knows how credit works? I’ve heard people build credits by getting department store credit cards, student cards, etc.

    Some of us can’t get any of those things, but we sure can take out a CD and get a secured loan against it.

    Again, it’s about getting started if all else fails. You will lose money in interest, it’s a given. It’s not to repair credit, it’s to establish credit.

  10. Horrible idea. Simply horrible.

  11. DougDascenzo says:

    nweaver: “If you want to build credit as a first timer, get a credit card and PAY IT ON TIME WITH 0 balance. Just keep that up and don’t worry.”

    That does work to get a high credit score, but that won’t help you get a loan, or even a lower-interest credit card. I always paid my entire credit card bill each month, and had no outstanding debt. My credit score was 770, and had a reasonably well-paying job. I applied for a low rate credit card with my existing credit card company and was denied. When I called to ask why, they said it was because I had no real credit history due to the fact that I paid my card in full each month. Essentially, I’d never had a real loan and thus couldn’t prove I could pay off a loan.

    It’s the ability to pay off a debt over time that lenders want to see. Instead of trying some crazy scheme with CDs or whatever, just buy something from a department store (furniture, tv, whatever) when they’re running one of those “no interest for 6 months” promos. When you do that, the store does their financing through a financial institution (e.g. Wells Fargo or some other lender). Pay the purchase off before the end of the promo, and voila! You’ve just established a credit history without paying a dime of interest.

  12. Incidentally, if you are going to college, you can get a credit card and buy your textbooks on it from amazon.com. You usually save a little on the textbooks over getting them at the bookstore, amazon delivers to your door so you don’t have to carry them (important to me on a walking campus!), and you can then pay the card off right away with your books money.

    By the end of four years, you’ll have some pretty reasonable credit history built up. By the time I graduated, having never charged more than $350 on the card, using it basically twice a year, and never carrying a balance, my $1200 credit limit was up to $8500 and I had enough credit history to go out into the real world of non-cosigned apartments, utilities, and eventually mortgages.

    The trick, of course, is not to fall into the college student trap of abusing credit cards.

  13. thrillhouse says:

    Don’t be so quick to take ‘credit building advice’. And taking personal finance advice from your loan officer? Seriously? he wouldn’t have a conflict of interest, would he?

    You are not a credit risk because you are responsible with your money. Ask you loan officer about Manual Underwriting. If he doesn’t do it, the find one that does.

    Baz – you don’t need those cards anyways, so stop drooling over them. If you don’t understand how credit cards and the credit system works, then you shouldn’t buy into it.

    And for any of you “first timers” – don’t take personal finance advice from lenders and broke people. Learn about what you are getting into, and the best place to go for that is Daveramsey.com

  14. Ask you loan officer about Manual Underwriting. If he doesn’t do it, the find one that does.

    What is Manual Underwriting? Never has Google been less helpful (I keep getting pages talking about Automatic Underwriting or it gets mentioned but not explained).

  15. MostNutsEver says:

    From what little I understand from my days as a GE Money Bank phone rep, Manual Underwriting was a department out in India that could sell higher dollar value loans and change terms on interest rates. We could not personally negotiate any of the terms of the loan besides the length after we collected the information and put it through our system. Only if a certain code came up (or if the limit was > $15,000), then we could transfer it over to MU to let them sell it.

  16. Magister says:

    Automatic Underwriting is where the underwriting is done by a computer using your data and determining if you are a good risk. Manual Underwriting would just mean that he overrides the Auto Underwriting decision.

  17. Triteon says:

    I’d like to point out that UMB gave me that advice, not that I necessarily decided to follow it. A simple letter from my landlord showing years of prompt rent payments plus a sizable down payment (told you I saved!) helped me secure the loan.

  18. Manual underwriting is the old-fashioned way of doing loans, with the banker sitting down across the desk from you and having you produce a variety of paperwork. It’s the pre-FICO system.

    Automatic underwriting uses your FICO number to spit out risk data and numbers on how much to lend you, at what rate, mortgage points, etc. The banker then usually has a little leeway within that system, but not much.

    Manual underwriting is more expensive (substantially so for the bank), more prone to human error in making lending decisions (although we all know credit reports are FULL of errors!), and many banks do charge more in loan transaction costs for manual underwriting — if they do it at all. Manual underwriting also takes a lot longer — there’s no instant approval.

    It is a good option for the individual who doesn’t use credit cards or loans but lives within his means. It’s more hassle than automatic underwriting, and may cost a bit more, but if you prefer not to invent yourself credit just to have a credit score for getting loans, it’s a good way to go.

    One of the best places to get manual underwriting is a credit union specializing in low-income customers, like Self Help Credit Union in North Carolina. Since the majority of their mortgage and small business lending is to consumers who are otherwise “unqualified,” they have a great deal of expertise in assessing risks for people outside the FICO system (or with low FICO scores), and they do manual underwriting every day.

    Interestingly, manual underwriting is considered riskier than automatic underwriting, but Self Help has the lowest mortgage default rates of any bank in North Carolina.

  19. rich815 says:

    It will work fine. In the short term. People do not always realize that your FICO scores are based on recent credit usage for the most part, and even if your FICO is high, without outstanding lines and usage within the last 6 months many banks will not easily approve you for large loans like mortgages, at least at the “A desk” rates—which are the best. As a home mortgage consultant at the top mortgage originator in the country I can share about a recent customer who had FICO’s in the mid-700 range but had no outstanding balances nor had he used any credit card or installment debt for over six months. Because of this we could not “auto” approve him with our computerized decision engine (which is where you get the best rates and terms, like no income and no asset verification w/o extra charge). There simply was insufficient recent use of credit to evaluate him. We could still approve him but he needed to provide other sources of good recent credit such as 12 months of cell phone bills, utility bills and a letter from his landlord, all showing paid as agreed and no lates. And if he wanted to do no income verification it was now going to cost him a 0.50 point add-on to do so. Bottom line? Consistent and current use of credit is the name of the game. Pay your bills with a credit card and pay it off every month, buy a car on credit, pay it for a few months and then pay it off whole if you can (used and paid off installment debt really helps your core credit score). And one more thing. Do not be so quick to close your credit cards. One guy sat down with me and said his credit was great as he paid off and closed all his credit cards over a year ago. We ran his score. It was in the low 600’s. Again, he had no recent credit use to score him from. And had no current credit lines either. FICO cannot figure a score when there’s nothing to score on. Best to keep at least 2-3 cards open and active.

  20. AcidReign says:

    …..I went to college during the Nixon/Ford/Carter era of runaway inflation and interest rates. I applied for student loans, and dumped them into 15% CDs, then paid them all back in full at the end, and had a pretty big chunk of change left over. And after a getting a real job, paying bills on time, and having a decent checking account balance, I’ve never lacked for credit offers. I didn’t even have to work at it. My first credit card was one Compass Bank begged me to take!

    …..It’s kind of silly of them, really. I always pay the whole balance every month. It’s not like I’m going to be a lucrative customer!

  21. thrillhouse says:

    That, Triteon, is manual underwriting. They look at the person, not a number. Congrats! It was really hard and you got a really bad rate, right? Of course I’m kidding, but this is what the debt mongers want you to believe – that the easy and best way is by being their slave for years and years and years, and playing all of their games so that maybe, just maybe your FICO score will go up 6 points. Its an absolute falsehood that you need a credit card or a FICO score to get a mortgage. You need an income proportional to what you are buying, you need to have payed your landlord on-time or early for 2 years, but your don’t need a FICO score.

    Lots and lots of places do manual underwriting or traditional mortgages, but they will do a FICO loan first if they can because it is easier on them. Churchill Mortgage is a good place to talk to.

    As for UMB- no, they aren’t MBNA or AmEx, but they are still a bank. Don’t take financial advice from someone trying to sell you a financial product (like a loan, or an investment). You need to find someone in your area who is a financial advisor who has the heart of a teacher and not a salesman.

  22. falsefridays says:

    I think it might be worth pointing out that doing something that is a debatable risk simply to raise your credit score seems a bit off-base to me.

    Personally, I’m not planning on having the desire (or ability) to buy a car or a house in the next few years anyway, and I think that the danger of getting credit cards “just to establish credit” is that, like me, you might end up racking up huge credit debt by the time you are 21, freak out for a few years, and then spend the next four paying it off in credit counseling.

    Get a bike, and rent a place with friends. You won’t spend all of your time wondering how to pay your car payment and your mortgage bill, and you might find that your life is richer as a result.

  23. rich815 says:

    “Some of us can’t get credit cards without credit in the first place.”

    This is wrong. Many banks will give pretty much anyone what are called secured cards. You put $100, 200 or 300 in a savings account with them. That now becomes your credit card limit. They issue you a card. You use it as much as you like (up to the limit). After a year with no late payments you are entitled to a non-secured card, usually with a higher limit.

  24. nikolay says:

    To start building a credit history, open a secured card with Bank of America as they will automatically convert it to unsecured 6 months after opening. Other banks usually do it after one year. I did it myself and I’ve recommended it to many of my friends and it always worked. You don’t need to put down a lot of money! Even $300 will do, but it’s not practical, because sometimes you’ll need a credit card and the $300 simple won’t be enough.

  25. zyphbear says:

    This is a TERRIABLE idea. Only way you should even CONSIDER doing this is if you ALREADY had a long term CD with a bank and figured to help yourself a little while AFTER getting the CD established or could use a little money instead of breaking the CD. This is because if you open a CD and then same day (or same week) ask to open a Secured Loan based off this CD, it is a Risk for the bank and brings up alot of red flags. (Due to money laundering.) Some banks also have limits or minimums for the secured loans, like maybe your Loan must be for at least 12 months or at least one month less than your CD term, or both.

    Though some banks will not always report this kind of loan to the credit companies either, so you should verify they do before assuming anything. Since you are just borrowing off you own funds, they are NOT obligated to report your payments. VERIFY, VERIFY, VERIFY!