How to Pay Interest to Build Credit

By taking out a series of secured personal loans, each loan slightly larger than the previous loan, it is possible to establish an A1 credit rating in a relatively short span of time at very little out-of-pocket cost. The trick is to have cash or cash-equivalent assets to collateralize each loan.

Things You'll Need

• Assets to collateralize a loan

Instructions

1. Approach your banker or other lender with your collateral. If you are using cash in a savings or checking account to collateralize your loan, your lender may refer to your loan as a compensating balance loan. If you are using real estate or other hard assets to collateralize your loan, expect to receive a loan equal to 50 to 75 percent of the value of the asset.

2. Negotiate the terms of your loan. Demand an excellent interest rate and good terms---after all, your loan is fully secured so the lender has no risk in making the loan. Make certain there are no early-payment penalties.

3. Place the loan proceeds into a savings account or an interest-bearing checking account. Do not spend the proceeds. At the end of 30 days hand back the loan proceeds plus a small amount of interest from your own pocket to repay the loan in full. If you have kept the loan proceeds in an interest-bearing account for the preceding 30 days then the interest you have received can be used to pay a portion of the interest due on your loan.

4. Wait 30 days and then approach your lender for another, larger secured loan. Go through the same procedure a second time, paying off your new loan at the end of 30 days.

5. Apply for a non-secured loan once your second secured loan has been paid off. Since you now have excellent credit (and all it has cost you is a small amount of interest), your lender should be amenable to making you a non-secured loan. Repay your first non-secured loan after 30 days. At this point your credit rating will be excellent and you should be able to apply for a larger non-secured loan at excellent rates.

Tips & Warnings

• If you use cash to collateralize your loan (a compensating balance loan), your cash funds will be frozen during the period of your loan.

• Do not use the money from your secured loans for any purpose other than to repay the loans at the end of 30 days.