How to Build Credit By Taking Out Small Unsecured Personal Loans

[May 13, 2009.]

 

The larger the loan, the greater the risk for the lender--unless there is collateral involved.

Collateral (or the lack thereof) changes the lending equation drastically. Borrowers who understand this fact, and know how to work it to their advantage, can build credit by taking out small unsecured personal loans.

Even Large Mortgage Loans Easy to Make When the Collateral Is Strong

On the matter of collateral changing the whole equation, take the example of a large mortgage of, say, $800,000. It would be utterly impossible for almost anyone to obtain an unsecured loan of that size. But throw in a house that's worth $1.5 million as collateral, and it's a no-brainer of a loan.

It's a good bet for the bank that such a borrower will pay back the loan, no matter its size. Because there is another way for the bank to get paid, if the borrower doesn't do it voluntarily.

The bank takes the house.

Unsecured Personal Loans Are a Whole 'Nother Animal

Borrowing money without posting collateral, by contrast, presents an inherently risky picture to a potential lender. An unsecured loan sounds dangerous, and often is, for the lender. How is the lender supposed to get paid back if the borrower flakes out? There is nothing to take.

Lenders counter this risk in one of two ways: either by charging the borrower a high interest rate and fees, or by lessening the loan size so that if the money is lost it's not the end of the world.

For borrowers who have subpar credit and are looking to improve their credit, taking out a small unsecured personal loan may be a great method to build credit over time.

To see why this makes sense, it's important to view the situation from the perspective of a lender. If a borrower takes out a small unsecured personal loan, or a series of them, a lender is trusting that borrower to pay that money back. The lender is out on a limb, somewhat, with no easy recourse if the loan goes sour.

Honoring that commitment by paying back a small unsecured personal loan on time and in full shows that a borrower is credit-worthy. It shows that a borrower knows how to use credit wisely, and respects the fact that this money is a loan, it's not growing on trees just waiting for passersby to grab and eat.

Small Unsecured Personal Loans the Beginning of a Beautiful Relationship? Maybe

Borrowers who take advantage of fast unsecured personal loan products often find that a limited number of lenders work in this area. Common names of certain corporations show up repeatedly.

However, this should not be taken as a sign that the unsecured personal loan market is sequestered far, far away from the mainstream lending industry, including mortgages. Smaller, more niche lenders maintain relationships with giant multinational banks not only in terms of sharing information but even sharing personnel.

In other words, a borrower should never underestimate the possibility that a lender that provided a small unsecured personal loan may well be reviewing their mortage application someday.

Paying back small unsecured personal loans is a great way to properly prepare for such a possibility.

 

About Author:

Andrew Freiburghouse is a writer and businessman. He has worked as a magazine reporter, tax preparer, screenwriter, copywriter, and loan officer. He graduated from Santa Clara University in 1999 with a B.A. in English. Andrew was born and raised in the City of Los Angeles.